Will The Fed Hike?

The most anticipated, discussed and fretted about meeting of the Federal Reserve Open Market Committee (FOMC) is rapidly approaching. That meeting will answer the one singular question on every investors mind – will the Fed hike interest rates?

The chart below shows that the Fed has maintained near zero overnight lending rates for a period longer than any other in history.

The consequence of extremely accommodative monetary policy has been a blistering run-up in financial asset prices as “savers” were forced to chase yield in higher risk areas. However, there has been little translation through the real economy that has continued to limp along.

It is worth remembering that the Federal Reserve uses monetary policy tools in an attempt to foster full employment and maintain price stability. In other words, the Fed lowers interest rates to stimulate economic activity and spark some inflationary pressures. The raises interest rates when the economy begins to accelerate too quickly, and inflationary pressures are building to a point that it becomes a detraction to economic growth. The chart below shows the Fed Funds rate as compared to CPI.

In the late 90’s Alan Greenspan began an interest-rate hiking campaign as inflationary pressures were building in the economy. The sharp increase in rates beginning in early 1999 ultimately led to a suppression of inflation as asset prices plunged, and the economy fell into recession.

Then, starting in 2004, then Fed Chairman Ben Bernanke also launched a rate hiking campaign as housing prices, commodity prices (oil) and asset prices were rising sharply. The inflationary pressure build in the economy became a concern, and ultimately, increases in Fed interest rates once again quelled those concerns. Unfortunately, the quelling of inflation was combined with an unprecedented global financial crisis.

In the next few days, Fed Chairman Janet Yellen will announce whether or not she will begin further restricting monetary accommodation by lifting the overnight lending rate. She will do so with both inflation and economic growth at levels lower than at any other time in history.