This post is about what I think the Fed should do not what I think they will do. After flinching in June, it’s obvious that the people of the FOMC are incredibly risk averse, and a July rate hike would be a bold move that seems beyond their character. With that said, I believe that a July hike is their best option therefore I cannot rule it out.
Right now the Fed’s credibility is under fire. After bringing out presidents and governors to talk up the odds of a June rate hike, the Fed unsurprisingly flinched. Blaming BREXIT is a cover and a terribly poor excuse that only a fool would find appropriate. The truth is the Fed is trapped and they know it.
The NFP data did not support a hike. The slowing economy did not support a hike. The weakening and increasingly unstable Chinese economy certainly did not support a hike. The soon to be European banking crisis did not support a hike. But the Fed’s waning credibility and, this is key, DID.
More and more important people are finally starting to question the Fed’s credibility. The Fed set themselves up for this seemingly grand gesture and then got cold feet at the last second. Normally a 25 bp hike would be a very small gesture but the Fed’s repeated mistakes have amplified this move 100 fold.
Every time they come to the table only to back off at the last second, the Fed sends a message to the market, 25bps is a big deal. As a direct result, when the Fed decides to delay a rate hike the dollar falls 2% causing all sorts of havoc in the markets.
I think the trend of waning central bank credibility is growing and if the Fed doesn’t act soon, it will be too late. The market knows that the Fed won’t hike right before the election which makes July the last available date to do so this year. I have serious doubts that they could hike in December. The economic data both US and globally will not be supportive (to say the least) and the Fed’s credibility will be so low that the market will have not priced in a December hike.
Given all this, I believe the Fed has to hike in July. Their credibility is at risk and their credibility is all that they have left. Obviously the repercussions for a July rate hike will be quite harsh. At the very least the Fed will maintain its credibility for a little longer with an extra round in the chamber to fight the next recession rather than being left with just a single shot.