Federal Reserve Board threw Wall Street for a loop, holding the Federal Funds Rate at zero-to-a-quarter percent, the same rate former Fed Chairman Ben Bernanke set Dec. 16, 2008. Beranke confronted an economic calamity in 2008 of epic proportions, not seen since the Great Depression. Using every tool at his disposal, Bernanke bailed out the nation’s biggest financial institutions that had run out of cash to the tune of $1.5 trillion. Keeping rates a zero helped create the biggest bull market in U.S. history, taking the Dow Jones Industrial Average from its March 9, 2009 bottom of 6,547 to its May 19, 2015 high of 18,312. Slow growth in China and Europe triggered a sell off that dropped the Dow Sept. 2 to 16,028 or 13.5%, largely over sluggish growth in China and Europe. Holding the interest rate sword over the markets also didn’t reassure major mutual, hedge and private equity funds.
Yellen’s decision to hold off on hiking the federal funds rate, despite last week’s drop in unemployment to 5.1%, mirrors data on low inflation, a sign that consumers don’t have the expendable income to boost U.S. Gross Domestic Product. Yellen heeded calls from European Union officials, especially International Monetary Fund Managing Director Christine La Garde, seeing a U.S. rate hike as hampering economic recovery in the EU. “Recent global economic and financial development may restrain economic activity somewhat and are like to put further pressure on inflation in the near term,” read the Federal Reserve Board’s Open Market Committee statement. When Yellen talks of further pressure on inflation, she’s worried about deflationary pressure, where wage and prices tend to go down. Yellen’s decision to hold off tightening monetary policy directly mirrors a weak economy.
Good news for Wall Street isn’t necessarily the best news for Main Street. Keeping rates at zero, a consensus of Federal Reserve Board economists believe that the economy could not sustain a rate hike without risking further drop in GDP growth. Growing at only 0.6% in the First Quarter, the economy picked up steam, with the Commerce Department reporting 3.7% GDP in the second quarter. Yellen’s decision to not raise rates suggests that Third Quarter GDP has once again petered out. “On balance, labor market indicators show that underutilization of labor resources has diminished since early this year,” said Yellen’s report. Looking at underlying weakness in wage growth in the labor market directly relates to the loss of good-paying federal jobs once the backbone of the U.S. middle class. GOP-dominated Congress opposes adding more federal jobs.
Wall Street’s read of the economy after Yellen’s decision caused an immediate 100-point bump, then a 200-point sell-off. Reading the Fed’s tea-leaves they see continued slow growth for the immediate future. While the GDP numbers for the Third Quarter aren’t out yet, the numbers look worse for the Q3. Despite the 3.7% GDP Second Quarter, the Fed expects 2015 to end around 2.1% growth, continuing into 2016 and 2017. Raising rates would have risked reversing GDP growth, potentially pushing the economy into recession. Looking at a 1.4% core PCE [Price Consumption Expenditures], the FOMC concluded it was too risky to hike rates. Debating at the Reagan Library in Simi Valley, California, 15 GOP candidates ripped President Barack Obama’s economy. Today’s Fed decision, at the very least, shows that the economic recovery isn’t complete.
Richmond, Virginia Fed President Jeffrey Lacker disagreed with Yellen’s decision to hold off on a rate hike. Lacker believes the FOMC’s September meeting might have been the last chance to raise rates in 2015 without consequences on the Christmas buying season, key to GDP growth. Yellen used the Fed’s data, especially on inflation, to determine that there’s too little room for error. Some economists believe the Fed’s inflation estimates of 1.4% are overly optimistic, given the sluggish consumer activity. Concerns about China’s slowdown and currency devaluation delayed Yellen’s decision to hike rates. Europe’s slow recovery and ongoing immigration crisis also weighed on Yellen’s decision to error on the side of caution. Like her predecessor Bernanke, Yellen wants to see more sustained consumer activity before tightening U.S. monetary policy.
Less than a year from ending the $85 billion a month bond buying program known as quantitative easing, Yellen isn’t ready to start hiking rates given the low wage growth and inflation numbers. While Wall Street will no doubt cheer Yellen’s decision is still bad news about the economy. Raising interest rates would have been a positive sign that the Fed’s FOMC sees the economy as healthy enough for a rate hike. Wall Street initially met today’s news of no rate hike with a quick buying spurt, only to watch hedge and private equity funds sell-off at day’s end. As the market digests Yellen’s decision, it could mean more correction before moving upward. No matter how many economists pushed Yellen to raise rates, the numbers are the numbers. Tightening too soon, only one year out from ending QE3, could have pushed GDP to flat-line or worse sink back into another recession.
