Fear and the FOMC

The current tone on Wall Street is that the Federal Reserve will destroy all that you hold dear. Not only will the Fed raise interest rates, Janet Yellen will give your credit card number to the Russian mafia. Members of the Federal Open Market Committee will dig up your dead grandmother and kill her again. You will get chestnut blight.

Bear in mind that we’re talking about raising the federal funds rate to 0.25% from zero.

But Wall Street probably does have two things on its mind, at least when it comes to Federal Reserve policy. The first is that it’s not entirely clear that an interest rate hike would be a good idea. As Calculated Risk notes, the key sentence in last month’s statement by the powerful FOMC is this: “The Committee anticipates that it will be appropriate to raise the target range for the federal funds rate when it has seen some further improvement in the labor market and is reasonably confident that inflation will move back to its 2 percent objective over the medium term.”

fourweekThe labor market has indeed been improving. The unemployment rate is 5.1%. Initial jobless claims were 275,000 the week of September 5. The four-week average rose slightly, but is still at historically low levels.

But there’s room for improvement. The total percentage of the unemployed, including those who would prefer to be working full-time but are working part-time, is still hovering around 10%. More importantly, real wages remain stubbornly low.

The other item the Fed wants to see is inflation at about 2%. Using the headline level for the Consumer Price Index, which includes food and energy, inflation is running at 0.2%. If you throw out food and energy, prices have gained 1.8% the 12 months ended July. The Fed’s own favorite inflation measure, the price index for personal consumption expenditures, has gained 0.3% the 12 months ended July.

Furthermore, a rate increase would simply propel the already strong dollar higher, which has been making other countries, most notably emerging markets, miserable. So there’s great uncertainty about whether the Fed will raise interest rates this month, and Wall Street just hates uncertainty.

The other fear is not so much a quarter-point increase in rates, which isn’t going to bankrupt anyone. Instead, it’s the notion that this is just the first in a long series of increases. All other things being equal, this means that bonds and money funds will eventually become more competitive with stocks and that Fed’s longstanding easy money policy will be over. Stocks will not only have to be the best-looking investment available, they will have to earn investors’ attention through higher earnings. And given the current level of earnings — near-record, but showing signs of slowing — that won’t be easy.

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