When the Fed meets from December 18-19, it is expected that they will increase interest rates yet again. This will continue the trend that began in late 2015 which has featured eight interest rate hikes. The question is now if the Fed will increase interest rates once or twice by March 2019.
Powell and the rest of the Federal Open Market Committee (FOMC) have made it quite clear that they intend on increasing interest rates at the December meeting despite a recent market downturn. However, I expect that the Fed will not increase rates again in March of 2019. The slowing in interest rate hikes will be a result of many contributing factors leading to slowing growth. A few of these contributing factors that should lead to a slowing in increases of interest rates are the recent decline in stocks, sinking price of oil, and the trade tensions with China.
A decision to not increase interest rates would benefit stocks significantly as stocks in all sectors have fallen off a cliff since YTD highs in late September. The decline in stocks is a result of global trade tensions, a bear market for FAANG stocks mostly led by decreased guidance in production for Apple (AAPL), and the continued expectations of increasing interest rates moving forward. A surprising result at the Fed meeting in December would significantly boost the economy as a cheaper ability to borrow would not be priced into the market. It feels as if the Fed is being incredibly stubborn as it continues to increase interest rates because the economy does not seem to be overheating. Yes, unemployment is at a 49-year low, but inflation is also at approximately 2% which is the target rate for the Fed. The Fed is being overly cautious and negatively affecting the stock market when the rising rates are unwarranted.
Another reason why the Fed should not increase interest rates in December is that oil prices have reached a 3-year low. Oil is historically an initial indicator of future economic slowdown because a decrease in oil price represents a decrease in demand. This decrease in demand signals less economic activity. By slowing down rate increases, the Fed could revitalize the oil market because a decrease in interest rates decreases consumers’ and manufacturers’ costs. This decrease in costs increases the amount of money spent on oil and henceforth increases the demand (price) of oil.
Possibly the largest cause of the recent economic slowdown is the trade tensions with China and the fear that it has instilled in investors. Tariffs have led to increased domestic prices in America as well as potential boycotts of major U.S. companies such as Apple and Nike. I am confident that a deal will be met with China sooner rather than later, although the prospect of a deal at this week’s G-20 summit is looking dimmer by the day, and this deal’s benefits moving forward will far outweigh the costs burdened on Americans over the last six months. However, as we await the culmination of this deal, it is imperative that the Fed is working in line with our foreign trade motives. That being said, it is important that the Fed operates as an independent entity. They should not be influenced by the harsh criticism deployed by President Trump but at the same time they should not operate independently of the United States’ foreign trade policies. As of right now they are amplifying the negative effects of the tariffs. It would be in the United States’ best interest for the Fed to slow rate increases during times of trade tensions in order to weaken the dollar and give markets a boost that could help offset the blow that is caused by the increased costs of the current financial climate. However, the Fed has continued to increases rates, and by doing so they are amplifying the short-term costs that were expected to surface as a result of the tariffs.
The stock market, oil, and the short-term costs of global trade tensions would all benefit significantly from the Fed reassessing their plan to continue the rise of interest rates. It seems to be a foregone conclusion that interest rates will be hiked in December but expectations of two interest rate hikes by March 2019 are decreasing. FactSet has reported that traders now see a 34% chance of two rate hikes by March 2019 as opposed to a 49% chance just one month ago. Although it seems as though we should begin thinking about Fed meetings of 2019 as the fate of the December meeting already seems to be decided, the fact that consensus is so sure that a rate hike is coming would only amplify the impact of a surprise. If the Fed changes their mind and decides to not increase rates in December, any chance of a recession will certainly be subdued.