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The Fed’s Dilemma

Sigma Investment Counselors

September 7, 2016

It is not exactly a secret that the Fed would like to increase interest rates but isn’t actually doing it.  The problem may be that there does not appear to be any compelling reason to raise rates at this time and at least two good reasons not to.

The Fed’s mandate is to maximize employment, stabilize prices and moderate long-term interest rates.  Unemployment is currently below 5%, but work force participation is at or near record lows.  While we are beginning to see some upward pressure on wage rates, low work force participation suggests that there may be a reservoir of potential workers, if the price is right.  Increased work force participation would probably benefit the overall economy, suggesting that the Fed is unlikely to want to raise interest rates to put a damper on wages or hiring.

Inflation is not a problem at present.  While the overall inflation rate is below 2%, service sector increases are higher while prices for goods are actually negative.  This may be partly a function of the strong dollar.

There are at least two good reasons for not increasing interest rates.  Higher rates, over time, will make it more expensive to service the ever increasing national debt.  In addition, raising rates would likely further strengthen the dollar, making imports cheaper but adversely affecting export sales.

In sum, by doing nothing, the Fed would be able to continue to support its primary mandates.  Much as the Fed seems to want to raise rates, this may be a solution in search of a problem.

All comments and suggestions are welcome.

Walter J. Kirchberger, CFA®

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