The Fed Might Not Raise Rates This Year
Yesterday, I wrote a fairly lengthy discussion on the biggest fear of the Fed is deflation. As I stated:
“The biggest worry of the Federal Reserve, and frankly every Central Banker on the planet, is deflation. The reason is that deflation, as an economic pressure, is dangerous and once entrenched becomes difficult to break.”
Another point can be seen more clearly in the chart below of 5- and 10-year breakeven inflation rates versus GDP. While the consensus of economists expect GDP to accelerate in the months ahead, there are many data points (oil, copper, lumber, shipping rates, etc.) that suggest real economic activity is actually slowing down. The current trend and level of interest rates confirm the same as money continues to seek safety over risk.
This potentially puts the Federal Reserve in a box given that they are laying the verbal groundwork that they will begin raising interest rates in 2015. However, the inflationary data is suggesting that this will likely not be the case. As I wrote previously:
“During the past 25 years, there has never been a period when the Fed has initiated a tightening cycle with inflation below its 2% target as it is currently. Furthermore, the decline in the breakeven inflation rates suggests that inflation will decline further in the months ahead which puts the Fed at risk of exacerbating economic weakness if they move forward with interest rate hikes.”
This is the risk to investors the in domestic markets. The news and data flows have been deteriorating post the “rebound” from the first quarter slump. With the Fed leaving the “party” the realization that a world without liquidity driven support could turn “bad news” into “bad news.” This is particularly the case when economic growth is running on razor thin margins and an exogenous event, such as plunging oil prices, leaves a very low margin of error.
