Fed needs to raise rates to avoid fate of other nations

Ahead of every Federal Open Market Committee meeting, investors get all whooped up into a feeding frenzy over whether the Fed is going to raise the short-term interest rate. Federal Reserve Chair Janet Yellen repeatedly states that the central bank is data-dependent. That seems reasonable. But the data will never give market participants the perfect set of conditions that render an interest-rate hike non-debatable.

U.S. Federal Reserve Chair Janet Yellen

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U.S. Federal Reserve Chair Janet Yellen

The strength of the data, including U.S. gross domestic product, has been uneven. Individual Federal Reserve bank presidents give conflicting speeches. Janet Yellen herself recently gave a (relatively) hawkish speech, only to walk it slightly back due to the recent May jobs miss shocker (100,000 below expectations).

If Yellen ever needed an excuse to hold rates steady for the next few FOMC meetings, this surely would suffice. But I hope she doesn’t use the excuse.

By now you have heard every case for and against a rate hike. Here’s my case why Yellen and her media-loving band of FOMC colleagues should raise the federal funds rate one quarter of a point (0.25 percent):

  • It won’t kill the stock market.
  • It won’t hurt the Treasury market, either.
  • It will help the banks to make credit more available.
  • It will help put to good use the trillions of dollars the Fed has printed.
  • And finally, it will keep the United States off the negative-interest-rate path followed by other nations.

Banks lend more when they are more profitable. Our domestic banks are literally getting crushed by the weight of their “ginormous” customer deposits at current ultra-low interest rates set by the Fed. The whole idea behind negative interest rates, via the European Central Bank and Bank of Japan, was to force banks to lend or suffer losses from having customer deposits. Their experiment, in my humble opinion, failed. Customers hoarded cash under the mattress, literally. It caused the banks to pull back more, not less, on extending credit.

Where do the bank customers put their deposits, if not under the mattress? Into gold, bonds and stocks — not the real economy, in the form of credit availability. Thank ECB President Mario Draghi and Japanese Prime Minister Shinzo Abe for their grand experiment. I hope our own central bank economists take those lessons to the bank (pun intended).

When the Fed raised the federal funds rate by a one quarter of a point last December after nearly nine years of being at zero, at first the U.S. dollar surged. But ultimately, with the ECB and BOJ going in the opposite direction, negative short-term rates resulted in their currencies strengthening. Less credit available and a stronger currency? That’s a backfire, if I ever saw one.

Will a hike hurt our Treasury market? I don’t think so. With $10 trillion of sovereign debt trading at negative yields, our Treasury securities will continue to attract buyers — maybe even more, which could actually keep long-dated rates lower for longer! But our banks would do better. Now that would be a great combination — lower long-term rates with easier access to credit. Seriously, have you taken a look at the yields on the 10-year bund and Japanese 10-year? If the Fed wants to free up the trillions of dollars it has printed, it needs to get the banks on board, which would rev up money supply, velocity and the multiplier effect.

Will a hike hurt our stock market? At first, yes, but not by much. In fact, after Yellen’s hawkish speech, stocks advanced. If investors were all torn up inside by a potential hike, they sure didn’t show it during that brief period when a June hike was possible and a July hike was likely.

Fed policy is a serious matter. We need to pay attention to it, understand it and make it part of our knowledge base. That’s how we wealth managers grow professionally. Same goes for you. But to be frightened over the prospect of ultra-low interest rates not being as ultra-low and that have reached the point of diminishing returns? Let’s just remember that we have been through many interest-rate cycles in the past and in the long run, focusing on investing in solid companies has created a lot more wealth than focusing on the Fed.

By Mitch Goldberg, president of ClientFirst Strategy

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