Are you saying that one good reason to put rates up is that you can bring them down again ?

Tuesday 18th August 2015

 Are you saying that one good reason to put rates up is that you can bring them down again ?

 

Ref : "U.S. Lacks Ammo for Next Economic Crisis", Jon Hilsenrath and Nick Timiraos, The Wall Street Journal, online.

How you view the prospect of the Fed's upcoming rate hike might just depend on how old you are. The youngest generation of traders will only have known near-zero rates and bearing in mind there has not been an upward move for almost a decade, a rise in the band for Fed Funds from the current 0.0 - 0.25% to 0.25 - 0.50 % or even 0.50% - 0.75% by year-end would be a pretty monumental event. Those longer in the tooth who have experienced much higher rates might simply see it all as a move back towards normality. There have been plenty of good reasons to engineer such a low-rate environment for so long, but many would point out that continuing with near-zero rates whilst an economy grows at say 2.5% is anything BUT normal, historically speaking.

 The dangers to the global economy that have played a part in staying the Fed's hand so far still exist and have arguably increased in number. Japanese Q2 GDP has contracted , China is fighting an economic slowdown whilst trying to avoid a stock-market rout. Its currency devaluation may yet spark trade frictions and a currency war. Eurozone Q2 growth has disappointed. Any one of the these or many other factors could bring about the next downturn. Consider that US expansion is entering its seventh year. It has already lasted sixteen months longer than the average growth cycle since WW2  --  none has lasted longer than 10 years. History says a downturn is inevitable  --  what will the US do when it comes ?

 The point being made (and it should concern others such as UK, Eurozone, Japan etc just as much or even more so) is that the US has always countered recession by injecting cash through interest-rate cuts, tax cuts or large public spending programmes. But with rates now so low, the scope for cuts is strictly limited unless one ventures into the world of negative short-term interest rates, the perceived view of which in the US is that they encourage businesses and households to hoard cash rather than to invest or spend. As for longer-term rates,  QE bond-buying programmes mean that the Fed already has about $4 trillion on its books and it's not clear how much more they could take on board.

 And on the fiscal side ? Would it be possible to inject short-term stimulus with an obligation to reduce expanding targets for the longer-term budget deficit ? The trouble is, that is not a matter for the Fed but for politicians, and given the diametrically opposed philosophy of Democrats and Republicans with regard to big or small government, agreement may be impossible to find.

Let's hope things improve for a while yet. When things do begin to fall apart again, it's likely that the Fed will have far fewer tools at its disposal this time round.