Flexibility For The Fed
By James Herrell, CFA, Director of Investments at Partnervest Financial Group, and Portfolio Manager of the AdvisorShares STAR Global Buy-Write ETF (VEGA)
The Federal Reserve appears to be all set to begin raising interest rates possibly as early as this Thursday. Economic conditions are favorable for liftoff; with strength in the housing market, positive GDP growth and the unemployment rate back down to 5.1%. This last data point in particular carries added weight, as the Fed has long maintained that it would not raise rates until job growth improved.
The consensus seems to be for a “low and slow” trajectory of interest rate hikes, beginning this year, and continuing into 2016. The Federal Reserve meets 8 times per year, and if they hiked rates just 0.25% every other meeting, the overnight Fed Funds rate would be at 1% in a year.
What might cause the Fed to pause? Overseas weakness, China in particular, might cause them to wait for fear of derailing the Chinese government’s stimulus and stability efforts. Even so, economic growth is positive across the developed economies. Collectively, the European Union, Japan and the U.S. comprise 52% of Global GDP. 1 While China may be capturing headlines, the real drivers of global demand are the G3 economies. As the chart below illustrates, unemployment continues to decline in these three regions, signaling an improvement in economic growth. This should foster further job growth, which in turn typically leads to stronger consumption and improved consumer confidence.
In summary, if the Fed wants to raise rates at their September meeting, they have enough positive evidence to begin doing so. If they chose to wait, then the first rate hike might come in October or December, but the end result is likely to be the same: a series of small hikes over time.