Why Did Fed Raise Rates Again?

Popular Economics Weekly

U.S. growth cycles have averaged about 8 years since WWII, yet the Federal Reserve just announced they were raising their overnight rate for the third time—to 1.25 percent. It also forecast that the unemployment rate could fall further, and economic growth continue for another one to two years, before the inevitable downturn.

What is the basis for their very optimistic prognosis with this growth cycle already 8 years old, and as Goldman Sachs economist Jan Hatzius says 8 years has been the average length of recoveries since WWII? We have a 4.3 percent unemployment rate, and one million fewer workers were hired (5 million in May) than the number of job openings (6 million) in the Labor Department’s latest JOLTS report, so what comes next?

Graph: Hatzius-Goldman Sachs

Fed Chair Yellen said that because of the tight labor market, price pressures are more likely to intensify. The unemployment rate fell in May to a 16-year low of 4.3 percent amid widespread reports that businesses are running out of qualified workers to hire, as I said.

In some cases, firms have sharply boosted pay to attract or retain workers, and the Fed believes that is always a red flag for incipient inflation. “Conditions are in place for inflation to move up,” Yellen said in a press conference after the Fed action.

But inflation is nowhere in sight, nor are wages on average rising more than 2.5 percent, still to low to boost economic activity. The May Consumer Price Index was basically unchanged, which may be why retail sales fell in May, but are still rising some 5 percent. Retail sales aren’t corrected for inflation, so when prices fall, it can affect retail sales.

The annual CPI core rate without volatile food and energy prices is just 1.7 percent. The Fed just can’t seem to boost inflation, no matter how hard it tries to talk it up, so it has announced it will begin to sell its $4.5 billion cache of Treasury securities that were accumulated during the various Quantitative Easing programs that have driven interest rates to historic lows. The ten-year bond yield had sunk to an unheard of 2.11 percent, which is why mortgage rates are still at historic lows.

Republicans seem to want to improve the chances of another Great Recession with their passage of the Choice Act that rolls back all the Dodd-Frank regulations that are designed to prevent another Great Recession.

The New York Times just reported on its passage in the House last Thursday, “…a sweeping deregulation of the financial sector. It passed 233-186, with no Democratic support. One Republican, Walter Jones of North Carolina, voted no. This bill rolls back or weakens most of the protections put in place since the 2008 financial crisis through President Barack Obama’s Dodd-Frank Act.”

In their attempts to please Wall Street (how quickly they changed their tune once in power), they are doing everything in their power to remove any oversight, even putting the consumers main protection, the Consumer Financial Protection Bureau, back into the hands of those regulators that allowed the Bush era excesses to happen by looking the other way.

In their purview, the Lehman Brothers failure that started the panic and consequent Great Recession was “market cleansing”. Republicans are saying someone should be punished for the excesses, rather than those excesses be prevented with regulation, and it has to stockholders and homeowners (Lehman had funded all those liar loans without adequate collateral), rather than the banks which were bailed out by the Bush administration’s TARP program, and are now bigger than ever. So what happened to Too Big To Fail?

So the Federal Reserve seems to be operating in its own bubble of unreality. It is anticipating higher growth and inflation, whereas there are no signs of either. Or, it could be anticipating another downturn, and wants to be prepared for it by clearing out its portfolio of bonds. But in selling those bonds into the open market it will surely raise long term bond rates, and mortgages.

But in pushing up interest rates, it could in fact create the slowdown it seems to believe is about to happen.

Harlan Green © 2017

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