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Why the Fed Won’t, and Shouldn’t, Raise Rates Next Week

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Don’t expect the Federal Reserve to raise rates when policymakers meet next week. The odds of a rate hike — which would be the first in nine years — have slipped to 28% from as high as 54% in early August, according to Bloomberg.

Brett Wander, chief investment officer of fixed income at Charles Schwab Investment Management, says in a new note that the recent stock market selloff “could be the deciding factor” for the delay. Federal Reserve Board Chair Janet Yellen is “terrified that equities will continue their selloff after a rate rise.”

Former Treasury Secretary and presidential economic advisor Larry Summers blogs in The Washington Post that the stock market rout “has already done the work of tightening” that a Fed rate increase would otherwise have done, and a rate hike now could potentially revive the selloff while also slowing an economy already experiencing slower growth in jobs and productivity and low inflation.

Three Wall Street-type economists addressing a meeting of the New York Financial Writers Association Tuesday night all agreed the Fed is not likely to raise rates when its policymakers meet next Wednesday and Thursday, but each predicted different dates for the move.

Jim O’Sullivan, chief U.S. economist for High Frequency Economics — dubbed “the most accurate forecaster of the year” by MarketWatch for 7 of the last 11 years including the past four — expects the Fed will move in October rather than September because even though “the economy looks solid, the Fed doesn’t want to take a chance and be blamed for another big selloff.”

O’Sullivan says a rate hike is justified this year because unemployment is falling rapidly — it fell to 5.1% in August — and wage growth and inflation, though subdued now, will pick up when the jobless rate falls below full employment. The Fed’s dual mandate is to promote maximum sustainable employment and stable prices. It does this by setting an unemployment rate that it expects to not accelerate inflation — currently between 5% and 5.2% unemployment — as well as a target inflation rate, now at 2%.

O’Sullivan said that wages and inflation may be low now but are likely to pick up as the unemployment rate falls further and the Fed may eventually have to lower its “full employment rate” target to 4%.

Bob Brusca, former chief of the New York Fed’s international financial markets division, now chief economist of consulting firm Fact and Opinion Economics, sees no reason for a Fed rate hike at all this year — at the October or December Fed meeting.  “There’s no evidence of inflation anywhere … We’re creating a lot of jobs, but the quality of jobs is poor and the average hourly earnings rate of change is very slow.”

He suggested that the Fed remove the 2% target inflation rate from its after-meeting policy statement because otherwise it will “have real problems with credibility” when it does raise if wage growth and inflation remain sluggish. “I really don’t think that the Fed can persuasively argue that they’re reasonably sure inflation is headed to 2%.” Unlike Brusca, Beth Ann Bovino, U.S. chief economist at Standard & Poor’s, expects the Fed will raise rates this year, but unlike O’Sullivan she’s predicting a move in December rather than October.  

The employment side of the [Fed] mandate has been met to raise rates,” and the low inflation rate gives the Fed time to wait,” said Bovino, explaining why it won’t move in September. But, she said, the Fed is also worried about “keeping rates too low for long” because that could lead to “excessive risk-taking” and market bubbles.

“The Fed is trying to avoid that and that’s why it will move this year,” said Bovino.

She expects officials will wait until December and not move in October because the Fed is “afraid of news leaks” and doesn’t want to make a major move no official press conference scheduled after the meeting. She suggested that such a timing could increase odds of a leak.

“It’s a difficult economy … a half fast recovery,” said Bovino. Growth is running at 2.5% annually instead of 4.5%, which was the historic norm. “The old indicators don’t apply right now. It’s the slowest recovery in 45 years.”

Still, Rick Rieder, chairman of the  BlackRock Investment Council, says the current Fed funds rate isn’t justified given the economy’s current and future growth. He told CNBC the Fed should have raised rates months ago. 

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