Tumbling nearly 1,322 points or 7.2% since hitting its record high May 19 of 18,312, the Dow Jones Industrials have been in “correction” phase, selling off because of a global economic slowdown in Europe and China. Federal Reserve Board Chairwoman Janet Yellen and her Open Market Committee has practically stood on their heads trying to justify a miniscule but psychological rate hike, causing Wall Street’s VIX volatility index to go wild. Most economists have leaned on Yellen to pull the trigger on the first rate hike since former Fed Chariman Ben S. Bernake slashed the federal funds rate Dec. 16, 2008 to zero-to-a-quarter percent. With major banks running out of cash and the Fed pumping over $1.5 trillion in bailouts, Bernanke used every possible tool to keep the economy from lapsing into another Great Depression. Yellen ended Bernanke’s $1 trillion a year quantitative easing Oct. 29, 2014.
Since ending the Fed’s QE3 Oct. 29, 2014, Yellen’s Open Market Committee has watched every published metric to determine the appropriate timing for a rate hike. While there’s no rush to hike rates, it’s been eight years since Bernanke dropped the federal funds rate to zero. Watching the unemployment rate drill down to 5.3% practically guaranteed, under normal economic circumstances, that inflation would kick up to the point warranting a change in monetary policy. Yellen’s July FOMC meeting hinted strongly that she would hike rates at least 25 basis points at the September meeting. With Europe’s stubborn recession and the slowdown in China, International Monetary Fund Managing Director Christine Lagarde asked Yellen June 4 to hold off on hiking rates until 2016. Yellen hoped that the Fed’s standard inflation metrics would justify a small rate increase in September.
All the speculation about pricing rate hikes into the market continues cause Wall Street to sell off, pushing institutional investors, the nation’s biggest mutual, hedge and private equity funds, to take money off the table [out of stocks], putting it on the sidelines in money markets or bonds, where the 10-year treasury has plummeted to 2.08%, mirroring the market’s belief that Yellen will hold off in September. If Wall Street continues to sell off, it’s going to impact strongly Q3 economic growth, potentially flat-lining to zero U.S. Gross Domestic Product. If Yellen can’t get the inflation number needed to justify a rate hike, the economy risks zero growth or, worse yet, lapsing into recession. All the chatter from Austrian-leaning economists about the Fed’s easy monetary policy causing hyperinflation backfired, with deflation still looming in the U.S., Europe and China.
Given global economic concerns, hiking rates in September could fuel more deflation, pushing the U.S. economy into recession. Watching the S&P 500 drop below its 200-day moving average indicates more selling ahead for equities with only 48% of S&P stocks moving upward. After ending QE3 Oct. 29, 2014, Yellen expected the improved employment picture to drive more inflation. But with many of the jobs low-wage and part-time, it hasn’t fueled a boom in the consumer economy, accounting for over two-thirds the nation’s GDP. With global oil prices crashing below $40 per barrel, it sends oil-exporting nations into recession, reducing the demands for consumer goods in major markets like the U.S., Europe and China. Fed officials hoped at the July FOMC meeting that “maximum employment could take longer to achieve,” hinting the wage-growth was not keeping pace with more employment.
Between now and the September FOMC meeting, the Yellen will look carefully at the payroll data to see whether or not unit-labor costs continue to remain flat. If salaries look stagnant, given the global economic concerns, Yellen will likely follow Lagarde’s advice, holding off on any rate hikes. If Yellen holds off, it’s also unlikely she’ll act in October or December, fearing a disruptive effect on Q4 growth. Hiking rates in October could kill not only a year-end Wall Street rally but the prospects for a strong Christmas buying season. After taking on $4.5 trillion in quantitative easing on the Fed’s balance sheet, it’s unlikely, short of another stubborn recession, for more stimulus to be on the way. Holding interest rates at zero may be the Fed’s last tool to keep the U.S. economy from dipping into recession. Until something can be done about stagnant wages, the consumer economy continues to sputter.
Yellen finds herself caught between a rock-and-a-hard-place about hiking rates in September. Given the real global economic slowdown, hiking rates could trigger a major equities correction, hastening another possible recession. Pushing for rate hikes less than one year after ending the Fed’s $85 billion a month QE3 bond-buying program could be too much for the U.S. economy to absorb, after nearly eight years of stimulus. Instead of looking for signs of inflation to justify a rate increase, Yellen should look for what happened to today’s employment causing stagnant wage growth. Without wage growth, consumers aren’t like to be adding to U.S. GDP growth anytime soon. Since Obama took office Jan. 20, 2009, the GOP-dominated Congress has refused to add enough federal jobs. Putting the onus for job growth only on the private sector hasn’t been enough to boost GDP.
