That's a question not on many minds these days. At the risk of ruining the economy, how can they consider increasing the funds rate? The credit crisis is still around, the housing slump is deepening and perhaps the economic growth picture is not all that rosy. However, we have seen a big surge in the dollar and long term interest rates...which means inflation needs to be contained...by rate hikes. Dollar strength, rising long term yields and commodity price drops are pointing us in this direction.
They've Been Saying It All Along
Fedspeak has been warning us for weeks of an imminent rate hike...it's not if, it's when. Whether this comes in a series of hikes or periodic moves is speculation, but history shows these moves are done in a series. Recent speeches have pigeon-holed the governors in a corner of yes or no. We've spotted a more hawkish tone, and it has been getting louder and stronger. Certainly Bernanke is the key here, but how long can he hold off the pressure, or face a 1970s type problem? He was recently blasted by Congress for reckless behavior (may have been given a CUI...chairman under the influence).
Oil and Other Commodities Are Leading, Not Lagging
Oil prices peaked July 3, and that's when most other commodities also started to decline. For all intents and purposes, these drops may have been precipitated by an increase in the dollar vs. other currencies. We're not calling a flushout of oil here, though it has certainly declined sharply. Any long term chart of crude shows a bullish nature. However, the correlation with the dollar and commodities is very strong, and there is no denying a trend. We could see the dollar propped higher even after the Fed starts raising rates. In fact, it is this recent pickup in the dollar that makes me believe the Fed is going to be aggressive.
Why Would the Market Applaud a Rate Hike?
That's a good question, and for the life of me I can't understand it. Other than a strengthening the dollar, rate hikes are meant to slow a speeding economy and inflation. We've seen rate hikes celebrated in the past (see: 1999). Irrational behavior is somewhat curious and downright illogical at times, but that's what makes markets. Perhaps the Fed being ahead of the curve...let's face it, there is inflation everywhere, and they have been slow to acknowledge it. My money is on a rate hike sooner rather than later, but the market is clearly not considering it. Only about a 6% chance as of Tuesday for a 2.25% Fed Funds target rate. We'll have more clues with the GDP and employment reports this week.