Anticipating the Fed: When Will Interest Rates Actually Be Raised?

The Federal Reserve has been in the headlines for some time now over speculation that it will raise short-term interest rates this December for the first time in years.

Since the financial crisis, the Fed has kept the federal funds rate, or the rate at which banks charge other banks for loans, near zero to help the economy bounce back after the recession. They have also implemented quantitative easing, or the purchasing of government and other securities to increase the money supply and keep down interest rates. Given that these measures have been in place for years, the attitude among policy-makers is that the economy is finally stable enough to raise rates to a more normal level. When this will happen, however, is unclear.

Odds that December would bring the anticipated increase were over 50% earlier this year; they have now fallen to just 37%.

The growth policy-makers were foreseeing has been disputable. Only government spending has experienced a steady increase over the past year, with business investment, consumer spending, and net exports all plateauing. On top of that, the Labor Department released its weakest consecutive labor reports in almost two years for the months of August and September.

Poor performance in industries with high international exposure, such as manufacturing and energy, have officials worried that the U.S. economy may be suffering due to larger trends in a weak global economy. China just released its most modest GDP growth rate since the financial crisis, Japan saw a steep decrease in export growth, and the European Central Bank cut their expectations for euro inflation for this year and the next two.

William Dudley, President of the New York Federal Reserve Bank, sees the combination of these signs as an indication that raising rates now would be premature. “It’s true we thought we could raise interest rates by the end of 2015, but turbulence on financial markets, modest global growth, energy prices and macro-prudential imbalances are slowing this process down.” He does not, however, completely rule out a rate increase, pointing out that better jobs numbers between now and December could change the scene.

There are, of course, risks involved in raising the rate too early or too late. “There’d be an argument from a risk management perspective not to go too early because you’d risk causing the economy to slow,” said former Fed Chairman Bernanke, when explaining the hesitation to tighten policy. Raising the rate would also lead to a real appreciation of the dollar, which could hurt U.S. exports and American companies’ income from overseas, further dampening growth.  “The counterargument is you don’t want to go much too late because if you go way too late, you’ll have to raise rates really quickly and that would be disruptive.”

The issue of credibility is one the Federal Reserve struggles with, as financial investors are always skeptical of the Fed following through with the announcements it makes. A recent survey by The Wall Street Journal says that economists are taking the Fed at its word, with 64% of respondents indicating they believe December will bring a rise in rates. A previous poll conducted just two months ago revealed that 82% of respondents thought the December meeting would bring on the rise.

Some believe the Fed should wait until March 2016 to raise rates. Larry Summers, former Treasury Secretary, has been outspoken on his view that it’s too early to raise rates. “Now is the time for the Fed to do what is often hardest for policymakers. Stand still.”