Fed Holds Steady But Keeps Talking Rate Hikes; Will They Happen?

The Federal Reserve held pat on interest rates at its May meeting. The Federal Open Market Committee unanimously voted to keep the benchmark rate target at 0.75 percent to 1 percent. The Fed continued to express optimism about the state of the US economy despite the recent slowdown in growth and hinted future hikes remain on the table. But will they come to pass?

The move to leave interest rates unchanged in May was largely expected. The FOMC’s statement showed some concern about sluggish growth in the first quarter of this year. But overall, the Fed remained upbeat, and most mainstream analysts still expect at least two more rate hikes this year.

The Committee views the slowing in growth during the first quarter as likely to be transitory and continues to expect that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace, labor market conditions will strengthen somewhat further, and inflation will stabilize around 2% over the medium term.”

Craig Bishop, lead fixed income strategist at RBC Wealth Management, told CNBC, “The language was just really to acknowledge some of the slowdown and weakness that has been seen, but also to send the message that it’s not enough to deter them from their plans,” adding that “June is on the table” for the next rate hike.

Janet Yellen and company are telegraphing continued rate increases based on forecasts of strong economic growth. But does the data really support the optimism?

Actually, it doesn’t. In fact, a rational look at the numbers would seem to indicate some stormy waters ahead.

The Atlanta Fed came out with a growth estimate for Q2 at over 4%, this despite a dismal first quarter and preliminary numbers already below estimates in the first weeks of Q2. (Keep in mind, these same people also initially forecasts strong growth in Q1.) Peter Schiff called the Atlanta Fed’s prediction “crazy” during his most recent podcast. (You can find the full podcast at the end of this article.)

They actually are starting out with a much higher estimate for Q2 than they had in Q1 despite having all of this information about how weak the economy was in Q1 that they didn’t have a few months ago. How is this possible?”

If the Fed is leaning on unwarranted economic optimism, will the rate increases really come to pass? Not everybody thinks so.

In an article published in the Mises Wire, Dr. Thorsten Polleit, Chief Economist of Degussa and macro-economic advisor to the P&R REAL VALUE fund, said he thinks the Fed will ultimately chicken out on planned rate hikes. He noted that recent bank lending data in the US show a noticeable slowdown in bank lending rates that began last fall. That could be a sign of trouble.

The Austrian business cycle theory tells us that the injection of new money created through bank lending out of thin air causes an artificial boom; and that the slowdown of credit and money creation, let alone a decline in available loanable funds, turns the boom into bust.”

So, a drop in lending could indicate the first sign of air leaking out of the balloon. If things start to get hinky, will the Fed back off and try to keep its bubbles inflated? Polleit thinks so.

Either the boom goes on, and interest rates continue to remain at very low levels. Or interest rates move back to normal, and the boom turns into bust. An ongoing boom, accompanied with a return to normal interest rates, however, is the least likely scenario. If the Fed has learned from its most recent past, it wouldn’t be surprising if US interest rates will remain lower for longer.”

Peter’s explanation as to why the Atlanta Fed keeps pushing these wildly optimistic growth forecasts dovetails with Polleit’s view.

Why do they believe this? Well, because they did all the stimulus. They applied all their medicine, and so they expect the patient to have a full recovery. They don’t realize that they’re leaching the patient, and if the leaches don’t work, they just figure they need to give the leaches a little bit more time. And if they didn’t work in the first quarter, well, surely they’re going to work in the second quarter…Why do they want to do that? Because they want to still pretend that the economy is growing strong so the Fed doesn’t have to change their rhetoric, so the Fed can still act as if everything is fine and they don’t have to start talking about not raising rates, or admitting there is a problem.”

Of course, nobody knows what the Fed will ultimately do, but it sure looks like there might be a problem. If the Fed ends up acting on actual data, it seems the quest for interest rate “normalization” may well end up petering out.

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