Debate about the timing of “liftoff”—a hike of 25 basis points in the federal funds rate—has intensified significantly over the past few weeks, ahead of the Federal Reserve statement on September 17. Market participants are debating whether the initial increase will occur in September, later this year, or at all. Some even go so far as to worry about a grave policy mistake should the Fed raise rates in September. Rarely in my career have I seen so much debate and contention over an upcoming Fed meeting.
Let me first distill the debate, and then I’ll share with you where I stand.
On the one hand…..on the other hand
Based on the U.S. labor market, the case for a September move is extremely compelling. At 5.1%, the unemployment rate is within the Fed’s definition of “full employment,” and job growth remains steady, as we highlighted this summer in a research piece. Expectations of wage increases by American workers are gradually returning to more normal levels despite currently lagging actual pay gains. The labor market is not yet overly tight, but it is tightening.
Unfortunately, this is not an easy call to make, as the case against a September move is also very reasonable. The most prominent argument is that core inflation remains stubbornly below the Fed’s long-run 2% target rate into a third year. The recent tightening in financial conditions—primarily the further drop in commodity prices, reduced inflation expectations, and further appreciation of the U.S. dollar—may make policymakers not as “reasonably confident” as they would like to be that core inflation will soon return to a more normal 2% pace. It is the low level of inflation, not recent volatility in the stock market, that those in the wait-and-see camp should point to for the Fed’s holding off. Being concerned about market volatility is one thing; suggesting the Fed be captive to it is something else.
‘Dovish tightening’
In weighing all of the data and risk factors, I’m still in the September camp. Whether I am proved right or wrong, I am sure it will be a close call, perhaps even without a unanimous decision. It would not surprise me if the Fed moved rates up by a smaller increment (perhaps 12.5 basis points rather than 25). Either would clearly emphasize our view that this tightening process will be dovish, given the fragility in global growth in an environment when most other major central banks are contemplating further easing measures.