scorecard
  1. Home
  2. stock market
  3. The Fed is going to raise rates for 2 reasons

The Fed is going to raise rates for 2 reasons

Myles Udland   

The Fed is going to raise rates for 2 reasons

A 'Wall St' sign is seen above two 'One Way' signs in New York August 24, 2015.  REUTERS/Lucas Jackson

Thomson Reuters

Credit Suisse thinks there are two main motivations behind the Federal Reserve's imminent rate hike.

And neither of them really matter.

"We think the purpose of the Fed rate hike this time is more benign than usual: it is to insure against financial asset bubbles and to create room for easing into the next recession, not to control inflation by slowing down growth," writes Credit Suisse's Andrew Garthwaite in a note to clients on Thursday.

Data from Bloomberg indicates about an 80% chance the Fed raises interest rates on December 16.

Now, Garthwaite is looking at a Fed rate hike through the prism of someone focused on what happens to the stock market.

And so the question for Garthwaite is will the Fed's first rate hike in nine years create the conditions for a bear market in stocks (defined as a 20% decline from recent highs).

Garthwaite doesn't think so, writing, "Thus the likely Fed rate rise doesn't, in our view, signal an equity bear market until: i) the yield curve inverts; or ii) the US reaches full employment (which we think is when unemployment is at 4% vs 5% currently)."

But it's the characterization of the Fed's current motivations as "more benign than usual" that is striking.

Garthwaite's first point - that the Fed is raising rates to prevent any nascent asset bubbles for getting particularly unruly - seems fairly specious.

In 1989, Garthwaite notes that the Bank of Japan raised interest rates with the aim of causing a 20% decline in home prices in Japan. Prices eventually fell 80%, or four times more than the BoJ had hoped. And this example illustrates that when a central bank's actions are designed to create a specific effect in financial markets, the effects can be exaggerated in ways that ultimately lead to worse outcomes.

Of course, long-time critics of the Fed during the last few years will read this and say, "Duh!"

One of the most common criticisms of the Fed has been that they've turned to trying to actively manage markets, which will ultimately lead to them getting it wrong. And the decision not to raise interest rates in September following the late-August market volatility is seen as the most obvious manifestation of this "shadow Fed policy" to manage the S&P.

On the second point that the Fed is raising rates merely to cut them later, we'd note that on a call on Tuesday, DoubleLine's Jeff Gundlach - seen as one of the most respected voices on the bond market - was critical of this idea, saying that it makes "no sense."

Gundlach also argued that the Fed is raising rates purely for "philosophical" reasons. That is, the Fed has said it is going to raise rates, and so even though it shouldn't, it will do it anyway.

Which isn't that far off from what Garthwaite is arguing here.

The traditional view of monetary policy says you raise interest rates to tamp down inflation or economic growth that is faster than what you judge the economy can reasonably handle. And when the economy begins to slow you cut rates.

But with inflation below the Fed's target and economic growth, at best, matching expectations, traditional guidelines don't say the Fed needs to, or should hike now. (And a number of prominent commentators have argued to this end.)

But then again, interest rates at basically 0% for seven years isn't "normal" anyway.

NOW WATCH: Fed's Bullard gave us a great baseball analogy to explain what the Fed is doing wrong

READ MORE ARTICLES ON



Popular Right Now



Advertisement