The Federal Reserve Signals an Interest Rate Hike

The Dow Jones industrial average is an index of the 30 largest publicly owned companies based in the United States and has been marching to new highs – with no end in sight.

Blue Chip stock prices may be rallying on international capital leaving the European continent in search of safety out of concern of possible further European disintegration ahead of the upcoming April 23rd and May 7th French elections.

Under economic theory stock markets are leading indicators and predict economic the future. In essence, the current stock market rally is indicating a burst of economic growth just over the horizon. The penetration of the 21,000 level does not appear to be a technical top or the all-time high but rather the first thrust onto a new plateau with subsequent pull backs in the weeks ahead providing potential buying opportunities to new highs. The $64 billion question is whether the Federal Reserve will raise interest rates at the end of its upcoming meeting on March 14-15.

Recent stock market rallies appear to confirm the strengthening U.S. economy is providing asset inflation and thus ample reason for the Federal Reserve to begin removing accommodation, i.e. raise interest rates. Prices from the Chicago Mercantile Group 30-Day Fed Fund futures express an 80% likelihood of a rate hike. However, the Federal Reserve finds itself pressured on the international front not to raise interest rates by emerging market countries that issued debt denominated in U.S. Dollars. It will be difficult for the European Central Bank to maintain negative interest rates at the same time the Federal Reserve is hiking. Domestically, aggressive and unexpected rate hikes could spike the U.S. Dollar denting exports.

If the Federal Reserve were to forgo an interest rate hike this month while the 30-Day Fund futures indicates a probability of 80% it could lose credibility regarding its ability to clearly telegraph its intentions to the market. In addition, the Fed could risk falling behind the inflation curve while at the same time opening itself up to accusations that it did not have the will to raise interest rates amid a stock market rally out of concern it would falter from the removal of stimulus.

The trick and hope of the Federal Reserve is that current U.S. economic growth momentum is sufficient to sustain itself after the removal of accommodation.

By Ralph D. Preston
Contact the author Ralph Preston at rpreston@hwfi.com

 

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