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Fed should lay off interest hike tomorrow

Tomorrow, December 19, the Federal Reserve will announce the policy decisions they have made from meetings starting today. The economy had been going strong for most of this year and it seemed that their program of rate increases was reasonable to prevent overheating and inflation. Recently there have been environmental changes that should impact on their projections and change their course of action.


The trade war with China and most of the rest of the world has had an impact on many foreign economies, most notably China's. Their rate of growth has slowed. Earlier this year they were experiencing almost 7% growth. It has most recently gone down to 6.5%. Some experts predict it will struggle to top 6% next year. This is not something to panic about, but his a softening of expected world growth.


The financial markets have clearly signaled an expected softening in growth if not an outright recession. Most major indices are down 10-15% from their highs. While writing this the Dow Industrials are off by almost 12%, the more broadly based S&P 500 is off almost 13%, and the smaller company Russell is off its high by over 20%. Foreign indices are also sagging with Germany's DAX down over 20%, China's STI index by 16%, and the UK's Brexit challenged FTSE by 15%. None of these suggest overheating.


The flattening yield curve on U.S. Treasury obligations suggests a slowing economy. The following charts are from GuruFocus.com:



The yield curve chart to the left shows how unmistakably flatter it is compared to prior years. The chart to the right shows the relationship of the spread between yields on 10-year Treasuries and 1-year Treasuries and recessions. The indication is that raising short term interest rates is not needed. It may cause short term interest rates to be higher than longer term ones, referred to as an inverted yield curve.


The Labor Department's Consumer Price Index has risen 2.2% over the past twelve months, both the headline figure and without food and energy prices, the so-called core rate. This almost exactly on target. Job creation hasn't really changed much since 2011 and may be decelerating at the end of 2018 as seen in the following chart:



Source: Bureau of Labor Statistics

A quarter percent interest rate change is not huge. By itself it won't cause a recession. However it may make a recession somewhat more severe than without the increase. The Fed has a dual mandate of maintaining price stability and encouraging full employment. Currently the labor markets are approximating full employment. Inflation is on target. There really is no need to immediately make a move that would be regretted later. The Fed meets in another 6 or so weeks. The rate increase can be taken then if conditions improve, but right now is not the time.

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