The Fed: Analyzing Wednesday’s expected rate hike
In its capacity as the decision-making body for U.S. monetary policy, the Federal Reserve holds eight regularly scheduled meetings each year. Its two-day September meeting, the sixth this year, will conclude on Wednesday. The remaining two meetings will be held in November and December.
Over the past few years, the center of debate within the Fed has been its management of the benchmark fed funds rate, upon which short-term debt is often based. By adjusting this rate, it seeks to manipulate spending, investment, employment and inflation to promote economic growth. On Wednesday, the Fed is widely expected to raise the fed funds rate by another 0.25 percent to a target rate of 1.75-2 percent. This would be the third rate hike this year and the eighth since December 2015.
In justifying its decision, the Fed will likely reference the latest economic data that reaffirms the continuing strength of the U.S. economy. The Consumer Confidence Index, a key measure of optimism on the state of the U.S. economy, just reported its highest level in almost 18 years. This optimism has fueled consumer spending – the key driver of the U.S. economy that accounts for more than two-thirds of all economic activity. This strength in America’s retail industry has carried over to manufacturers. In August, the ISM Manufacturing Index, which tracks the growth in the U.S. manufacturing sector, reached its highest level in more than 14 years.
Along with its anticipated 0.25 percent rate hike, the Fed will also release its latest quarterly forecasts on economic growth, inflation and unemployment for 2018-2020. The Fed realizes that consumers and businesses continue to drive economic growth. It also knows this spending should lead to further gains in the labor market and gradually push inflation higher. However, the biggest unknown within its quarterly forecasts is the projected impact from America’s ongoing trade disputes.
At its last meeting in July, the Fed commented that “…if a large-scale and prolonged dispute over trade policies developed, there would likely be adverse effects on business sentiment, investment spending, and employment.” The challenge for investors, the financial markets and even the Fed itself is to determine what constitutes “large-scale” and “prolonged”.
The challenge in analyzing America’s trade disputes is identifying what total amount of tariffs will be the tipping point that will start to materially impact economic growth. Unfortunately, this still remains an unknown. Our trade disputes started back in March with President Trump imposing global tariffs on imported steel and aluminum. Since then, the U.S. has accumulated a hefty $71 billion in combined tariffs in its trade disputes with China, Canada, Mexico and the European Union. However, the economy has clearly proven it can readily absorb the impact from this level of combined tariffs.
Yet this does not consider the latest round of tariffs that went into effect last week. On Monday, President Trump imposed a 10 percent tariff on an additional $200 billion of Chinese goods. China quickly retaliated, imposing a 5-10 percent tariff on another $60 billion of U.S. goods. But in the aftermath of this escalation, the markets haven’t expressed much concern. In fact, the stock markets have actually been rising.
No, we shouldn’t expect too much from the Fed on Wednesday. It will likely announce its 0.25 percent rate hike and tell us the U.S. economy remains strong. It will present us with its latest quarterly forecasts on economic growth, unemployment, inflation and its projected interest rate hikes over the next two-plus years. However, there’s one thing it won’t provide – clarity on the economic impact of America’s ongoing trade disputes. For that, your guess is probably as good as the Fed’s.
Mark M. Grywacheski, Investment Advisor
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Quad Cities Investment Group, LLC is a registered investment advisor with the U.S. Securities Exchange Commission.
