Will the Fed raise interest rates?

October 29, 2015 02:48 PM

On Wednesday, the Fed Open Market Committee announced that it would not raise interest rates in October 2015. That means that Zero-Interest Rate Policy (ZIRP) has remained in place for 2,508 days and counting.

The Fed Open Market Committee (FOMC) said in a statement that it will continue to watch for advances in both consumer prices (inflation) and the labor markets in order to determine “whether it will be appropriate to raise the target range at its next meeting.”

The next meeting will take place in December, and members of the financial media are already chattering about how and why the Fed should raise rates next time around. In fact, CNBC has been speculating on interest rate hikes since late-October 2014, parallel to the Federal Reserve’s announcement that it was ending the third-round of its quantitative easing program.

The markets have priced in a potential increase for December, and economists--particularly members of the Federal Reserve--have argued that the Fed should tighten monetary policy at its final meeting of the year. The odds, however, favor March 2016 for the liftoff. CME FedWatch, which creates a tool to determine the probability of a rate hike at future FOMC meetings, shows that a chances of a rate increase is not greater than 50% until March.

So, should the Fed take action?

Here’s a breakdown of the Fed’s December decision.

Focus on the dual mandate

The Federal Reserve has a dual mandate in its obligation to the U.S. economy. The first is to ensure a healthy level of inflation—a target of 2.0% annually—while the second is to move the economy toward full employment levels.

Right now, the official September unemployment rate sits at 5.1%. The October jobs figure will be reported next Friday, and consensus expectations are for that level to remain unchanged. Meanwhile, the Federal Reserve has to address concerns that the percentage of Americans old and healthy enough to work is at its lowest level in more than 35 years. That said, the labor force participation rate continues to decline largely due to a high percentage of older Americans retiring, but still qualifying to be considered part of the workforce.

Overall, the labor markets are much healthier than several years ago, and weekly jobless claims are at their lowest levels in 42 years.

However, concerns about inflation are the true reason why a rate hike hasn’t come. Federal Reserve doves like Chicago Fed Bank President Charles Evans has largely encouraged the central bank to delay a rate hike until inflation levels return.

Currently, two important influences are impacting their measurement of inflation.

Around the world, foreign central banks have been debasing their own currencies in order to spur economic growth while the steep decline in oil prices around the global have affected nations that are heavily reliant on oil exports--a phenomenon that has driven down these nations’ currencies against the U.S. dollar.

Just last week, China announced that it will slash its interest rate for the sixth time in a year, just two months after it announced plans to depreciate its currency in order to boost exports and to meet its target growth rate of 7%.

Second, domestic wages are not rising fast enough. Mixed data has implied that the bulk of Americans are not making enough money. The Labor Department says that wages grew at 2.2% during the year, although polls suggest that most Americans haven’t seen a raise lately.

Fed officials expect that the consumer price index, less food and energy, will rise to roughly 1.6% to 1.9%. However, these might be too rosy. The Fed has missed its inflation targets for three years in a row.

In September, the Consumer Price Index for All Urban Consumers declined 0.2% in September after decreasing 0.1% in August. The index for all items less food and energy rose 0.2% in September after rising 0.1% in August.

In the end

With the Fed’s dual mandate in focus, the central bank will hold its final meeting on monetary policy in December.

Although the Fed has said it will consider a hike in December, this drama has played out for more than a year. Looking two months out, a focus on consumer inflation data will drive the debate.

About the Author

Garrett Baldwin is the Managing Editor of the Alpha Pages and the Features Editor of Modern Trader. An author and Baltimore native, he earned a BS in journalism from the Medill School at Northwestern University, an MA in Economic Policy (Security Studies) from The Johns Hopkins University, an MS in Agricultural Economics from Purdue University.