The Federal Reserve remains on track to raise interest rates again in December, according to the futures markets. But the wisdom for another round of policy tightening is drawing more criticism in the wake of a surge in stock market volatility and signs that economic growth has slowed in the US, China and Europe.
Richard Bove, chief strategist at Rafferty Holdings, for example, worries that ongoing rate hikes at this point in the business cycle threaten to push the US into a new recession. By his calculation, broad money supply growth is advancing at well below the pace needed to keep GDP rising at a healthy rate.
The senior fixed-income strategist at Rabobank also sees risk rising in the central bank’s ongoing policy plans to lift rates. “We think the Fed will ultimately push the US into recession by following this path,” said Lyn Graham-Taylor, senior fixed income strategist at Rabobank.
Regardless of the risk, former Fed Chair Janet Yellen thinks “it’s appropriate for the Fed to be raising interest rates a bit more,” she said on Tuesday.
Martin Feldstein, professor of economics at Harvard University, recently advised that the case for tighter policy is partly linked to giving the Fed more room to cut rates to fight the blowback in the next recession. By that measure, he reasons that the central bank is still behind in normalizing policy.
If a recession begins as soon as 2020, the Fed will not be in a position to reduce the federal funds rate significantly. Indeed, the Fed now projects the federal funds rate at the end of 2020 to be less than 3.5%. In that case, monetary policy would be unable to combat an economic downturn.
Meantime, the market is currently pricing in high odds of another rate hike at the December policy meeting. Fed funds futures currently reflect an implied 73% probability that the central bank will lift its target rate by 25 basis points to a 2.25%-to-2.50% range at the final FOMC meeting for 2019, based on CME data.
The negative trend in real M0 money supply aligns with the outlook for higher rates. This measure of monetary liquidity (also known as base money or high-powered money) continued to contract last month by a bit more than 10%, marking the seventh straight month of negative annual comparisons.
The effective Fed funds (EFF) rate is also signaling that rates will continue to rise in the near term. As of Oct. 29, EFF continued to hold above its 30-day average, suggesting that the path of least resistance remained up for this key rate.
Plans for ongoing rate hikes are receiving more scrutiny these days after the latest reports that economic growth is slowing in the world’s main economies. Last week, US GDP increased 3.5% — a solid pace but well below Q2’s 4.2%. The Atlanta Fed’s GDPNow model’s initial estimate for Q4 growth sees another downshift to 2.6%.
Meantime, China’s manufacturing PMI report for October suggests that the world’s second-largest economy is slowing as the trade war with the US heats up. Note, too, that Eurozone GDP growth for Q3 slipped to a four-year low.
But unless incoming US economic data is surprisingly weak, it’s not obvious that the Fed will abandon its plan for another rate hike. The first hurdle – this Friday’s employment report for October via the Labor Department – is expected to give the central bank cover for maintaining a hawkish bias. Econoday.com’s consensus forecast sees private-sector jobs rebounding this month with a 180,000 gain – sharply up from September’s weak 121,000 increase. If the estimate is accurate, the year-over-year trend for private payrolls will rise 1.9% — just slightly below September’s 2.0% gain (a two-year high) , which is a pace that’s strong enough to deflect concern that the economy is headed for a worrisome slowdown rather than a modest downshift.
But the question is whether headwinds in Europe and China will continue to weigh on US data in the weeks and months ahead? Based on the view from Main Street, those risks look overblown.
The Conference Board yesterday reported that that consumer confidence ticked up to an 18-year high this month. “Consumers’ assessment of present-day conditions remains quite positive, primarily due to strong employment growth,” said Lynn Franco, senior director of economic indicators at the consultancy.
The economic numbers overall still leave the Fed with a rationale to squeeze policy further. But there’s a lot of data releases between now and the Dec. 19 policy meeting. Meantime, investors are struggling to decide if the recent surge in stock market volatility is noise or an early warning of macro trouble ahead? For now, it’s reasonable to argue that the market’s hissy fit is an effort at discounting softer but still healthy economic growth. If there’s a darker reality lurking, the evidence will soon begin dripping out in the economic reports.