The long awaiting Fed rate raising cycle is now, officially upon us. The question of whether or not the Fed will raise rates has long been answered in the affirmative, and so, it is not a question of if, but when will the Fed tighten. June was almost universally forecast to be the first Fed meeting at which Fed governors would possibly vote to raise rates. The June meeting occurs on June 16th and 17th; next Tuesday and Wednesday. Friday’s jobs report, showing 280,000 new jobs added, which was well above the 210,000 forecast, provides a bit of upside pressure for the Fed to raise sooner rather than later. But a single data point is not enough to sway the Fed on such a major decision.
Many economists are forecasting that September will be the most likely month for the first rate hike. The Fed does not meet every month. The will meet this month, in July, and then not until September. If rates have not been raised by September, the Fed will still have October and December in 2015 to decide to start the rate raising cycle.
What is important to note is that, while market observers (including me) are focusing on the first rate hike, once the Fed pulls the trigger on the first hike, this will be a long-term rate raising cycle that will likely last several years.
The implications of this are many. The degree and magnitude of the negative impact on financial markets will depend on how aggressive the Fed is with rate increases, and the strength of the underlying economy during this process. If consumers continue to spend, despite rising rates, and therefore corporations also continue to spend, the economy may be able to continue to grow at a reasonable rate, even as rates are rising. This, of course, would be the goal of the Fed – to continue to see economic growth and job stability while curtailing inflation.
Unfortunately, this is a very difficult proposition. Rising rates certainly pressure consumer spending. We have a credit-based economy. Credit costs money, and that cost is the interest charged on the credit. The higher that interest cost, the more expensive it is for people to buy goods and services, and the more difficult it is to get credit in the first place.
Of course the Fed is well aware of these facts, and this explains why they have been so reluctant to start raising rates, despite the increasingly positive data we have seen on the economy. But the clock is ticking quite loudly now. Few economists would argue that we will not see the first rate hike sometime before the end of 2015. Personally, since everyone is expecting it, I feel the Fed would serve the economy better by moving ahead with the first rate hike sooner rather than later – better to get it out of the way with a small initial rate increase, let the financial markets react to it, and then move ahead with a slow, steady rate rising cycle.