During the last year, the Federal Reserve has hinted that the period of “ultra accommodative monetary policy” was coming to an end. The Fed started that process last October by terminating the latest “Quantitative Easing” program which induced massive amounts of liquidity into the financial markets. Subsequently, the Fed has turned its focus towards the near ZERO level of the “Fed Funds” rate.
Over the last several FOMC meetings, Chairwoman Janet Yellen has hinted on numerous occasions that the Fed will begin increasing the overnight lending rate sometime in 2015. She has been adamant that the Federal Reserve has been“watching the data” closely to determine the appropriate timing of those increases. Not surprisingly, Wall Street has also been singularly focused on this issue. The increase in lending rates is the final step in ending the extremely long period of “accommodative policy” measures that has been a primary support of asset prices.
The problem for the Fed, as I discussed recently, is that they may have already missed their best opportunity to begin increasing interest rates. To wit:
“While the Federal Reserve hopes that they can effectively raise interest rates without cratering economic growth, the problem is that the bond market may have already beaten them to the punch.
While I do not expect Treasury rates to rise very much, the increase in borrowing costs in an already weak economic environment has an almost immediate impact. The chart below shows the periods in history where Treasury rates have risen and the impact of subsequent rates of economic growth.”
Click on picture to enlarge
But it is not JUST interest rates that suggest that the best opportunity for the Fed to hike rates is likely behind them.
One of the important factors for continued economic expansion, and required to offset the drag caused by tighter monetary policy, is an increasing rate of wage growth to support an expansion in consumption. As shown in the chart below the correlation between wage growth and economic growth is very high. This relationship, of course, is not surprising given that the economy is almost 70% driven by consumption which is supported by wages.
