To Hike, or Not to Hike?
That is indeed the question that perplexes the Federal Reserve currently.
As I recently penned in "The Fed's Window For Hiking Rates Continues To Close:"
"The Federal Reserve has a very difficult challenge ahead of them with very few options. While increasing interest rates may not "initially" impact asset prices or the economy, it is a far different story to suggest that they won't. In fact, there have been absolutely ZERO times in history that the Federal Reserve has began an interest-rate hiking campaign that has not eventually led to a negative outcome."
While the Federal Reserve clearly should not raise rates in the current environment, there is a possibility they will anyway.
The Fed understands that economic cycles do not last forever, and we are closer to the next recession than not.
While raising rates would likely accelerate a potential recession and a significant market correction, from the Fed's perspective it might be the 'lesser of two evils. Being caught at the "zero bound" at the onset of a recession leaves few options for the Federal Reserve to stabilize an economic decline."
The Federal Reserve as of late have issued repeated statements that rates are set to rise at the September meeting.
However, with China's financial and economic troubles on the rise, the negative impact of the surging US dollar,
rising deflationary forces globally and falling asset prices; there is a rising probability they will push off the rate hike until the end of the year.
The problem for the Fed is they are now likely "behind the curve" and will be caught with interest rates too low when the next recessionary cycle sets in.
Importantly, as stated above, I am not suggesting that the economy is about to slip into an immediate recession. However, I am stating that all economic cycles do eventually end.
When the current economic growth cycle begins to contract, if the Fed is still stuck at the zero bound it leaves them few policy options available to offset the risk to the financial markets. This is why I tend to agree with Albert Edwards at Societe General
and his point that such a combination of events could lead to a mean-reverting event on par with the past two recessionary periods.
The combination of these data points continues to support my long-held thesis that the "Bond Bull Market"
is still far from over.
Despite the majority of analysts continuing to be wrong about rates rising, the reality is the persistent wave of global deflationary pressures will continue to support bond prices in the future.
Given that interest rates are ultimately tied to economic growth and inflation, it is highly likely we will see interest rates on the 10-year Treasury below 1% during the next recessionary cycle.
The Fed is rapidly coming to realize they are caught in a "liquidity trap."
The problem is they have been betting on a "one trick pony" that by increasing the "wealth effect"
it will ultimately lead to a return of consumer confidence and a fostering of economic growth?
Currently, there is little real evidence of success.
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