Over the last year, I have written extensively about how despite the Fed’s best intentions to raise rates, the real economic backdrop would likely impose a major impediment in doing so. However, I also suggested that with the Fed now caught in a liquidity trap, they would potentially hike rates to avoid being caught at zero during the next economic downturn. To wit:

“Currently, there is little evidence that is supportive of higher overnight lending rates. In fact, the current environment continues to support the idea of a ‘liquidity trap’ that I began discussing in 2013.

‘…a situation described in Keynesian economics in which injections of cash into the private banking system by a central bank fail to lower interest rates and hence fail to stimulate economic growth. A liquidity trap is caused when people hoard cash because they expect an adverse event such as deflation, insufficient aggregate demand, or war. Signature characteristics of a liquidity trap are short-term interest rates that are near zero and fluctuations in the monetary base that fail to translate into fluctuations in general price levels.’

Please review the chart on monetary velocity above. This is a major issue for the Federal Reserve, which remains firmly committed to a line of monetary policies that have had little effect on the real economy.

While the Federal Reserve clearly should not raise rates in the current environment, there is a possibility that they will anyway – ‘data be damned.’(Which is ironic for a ‘data dependent Fed.’)

They understand that economic cycles do not last forever, and that 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 if just 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 problem is that it already might be too late.”