Make no mistake, what you saw with the Fed’s September meeting and subsequent (in)decision was an FOMC that simply froze like a deer in headlights. As we’ve documented exhaustively, there are no right answers and Janet Yellen only made it worse by, in Deutsche Bank’s words, “removing the fourth wall” and admitting that the committee is reflexive.
The Fed cannot hike for fear that a soaring dollar will accelerate EM outflows and plunge the world’s most important emerging economies into chaos.
But remaining on hold risks precipitating the very same outcome because by missing the window for liftoff, the FOMC has fostered an environment in which all EMs are constantly on their toes with no idea when or even if the “symbolic” 25bps hike will ever come. The attendant uncertainty engenders the very same capital outflows as a hike might.
And then there are of course considerations about what the FOMC is telegraphing about the risks to the US economy. September’s “clean relent” telegraphed a dour outlook and that, in turn, weighed on domestic risk (apparently bad news is bad news again). But hiking and thereby conveying a positive outlook for the US economy could well cause the dollar to soar (because if the ECB and BoJ are still easing, the policy divergence would be exacerbated in a liftoff scenario, giving the USD a strong tailwind) which would be a negative for some US corporates and could well weigh on the economy going forward.
So this is the impossible scenario the Fed finds itself in and it’s all complicated by the fact that we are heading into an election year. For his part, Donald Trump believes Yellen is deliberately delaying liftoff not because she is simply confused as to what to do, but because she’s trying to help the Obama administration. Here’s more via Bloomberg:
According to Donald Trump, Janet Yellen’s decision to delay hiking interest rates is motivated by politics.
“This is a political thing, keeping these interest rates at this level,” Trump, the billionaire Republican presidential candidate, said in a Wednesday interview with Bloomberg Television’s Stephanie Ruhle. “Janet Yellen for political reasons is keeping interest rates so low that the next guy or person who takes over as president could have a real problem.”
That problem spurred by raising rates, Trump argued, could be “a recession or worse.”
On the other hand, Trump faulted the Federal Reserve for not having acted sooner. “Yellen is keeping rates too low, too long,” Trump said.
Here are some other highlights from the interview:
“Yellen is doing this with the blessing of the President because he doesn’t want to have a recession – or worse- in his administration.”
“I’m a developer, I’m not complaining from my own standpoint, I’m just saying that at some point, you have to raise interest rates, you pay nothing. They are trying to put the recession – and it could be a beauty into the next administration.”
Now, it’s probably safe to say that Trump doesn’t understand just how convoluted the Fed’s reaction function has become at this point, which means he’s likely predisposed to thinking that the FOMC’s decision making is more political than it actually is. That’s not to suggest that the Fed is truly “independent” per se, it’s just to say that at this point, Obama’s legacy is probably not particularly high on the list of things that keep Janet Yellen up at night.
That said, there are very real questions as to whether the Fed will risk raising rates in an election year and on that note, we’ll leave you with some thoughts from BofAML as presented here first earlier this month.
Via BofAML’s US Economics Team,
Experience and independence both say “yes”
A popular view among some market participants is that the Fed is unlikely to hike in a presidential election year. While many economic and market factors may influence when and how often the Fed hikes in the upcoming months, we do not expect the timing of US elections to play any meaningful role in the Fed’s policy deliberations. Neither historical experience during the past several hiking cycles, nor the Fed’s own desire for policy independence, suggests this will act as any constraint on the hiking cycle. Rather, we expect the Fed to gradually tighten policy in a data dependent manner during 2016 — regardless of how the political winds may blow.
Recent history: most hikes during election years
Historically, presidential election years have not precluded policy tightening by the Fed. Of the last five Fed hiking cycles, four either began during or continued into an election year. Two of these — 1988 and 2004 — started in an election year, some months before Election Day (in March and June, respectively). Two others — 1983 and 1999 — began the year before an election, with hikes continuing well into the following year. Both these hiking cycles stopped before Election Day (in August and May, respectively), perhaps fueling speculation about the Fed’s motives. But the Fed did not resume hiking once Election Day passed — in contrast to what one should expect if the Fed were temporarily holding back hikes around an election. Rather, each of these tightening cycles concluded as the Fed returned rates to a more neutral stance.
Is past performance a good predictor of future policy? Given how strongly independence is held at the Fed, we suspect it is. Numerous studies show that politically independent central banks deliver the best inflation and growth outcomes, and Fed officials know that even the perception of political influence can undermine their best intentions. Rather than trying to avoid being news by keeping policy unchanged in an election year, the best strategy would be to move in a very deliberate, well-communicated and datadependent way — one that not only has nothing to do with the political cycle, but wouldn’t even give that impression. Indeed, if the Fed really wanted to minimize political pressure today, it is not at all obvious if the better choice would be to hike to appease its most vocal Congressional critics or to stand pat. Any action or inaction is bound to upset (at least) one party — so why even try?
Unlikely variations on an unlikely theme
Finally, the view that the Fed cannot or will not hike in an election year yields some unlikely implications for monetary policy. One is that the Fed has to get going very soon — and perhaps somewhat aggressively front-load rate hikes — in anticipation of sitting on its hands for some time. In contrast, Fed officials have warned that they don’t want to hike prematurely, and they have emphasized both a data dependent and gradual approach to normalizing policy. Another variation is that if the Fed delays this year, they won’t be able to lift off for nearly another year — and thereby put policy significantly “behind the curve.” But it’s hard to believe the Fed would choose to wait that long and potentially let inflation get out of control because of politics; recent speeches note the risks of hiking too late. In the end, while several factors could potentially delay Fed rate hikes, we very much doubt next year’s presidential election will be one of them.