The Fed’s Interest Rate Decision

In his blog on Fed watching, my colleague Walter does an excellent job of explaining and summarizing the Fed’s reasons for not raising interest rates last week.  Many market participants seem frustrated by the lack of action by the Fed.  Admittedly, as the Fed continues down the road less traveled, the lack of an interest rate increase does create uncertainty and discomfort for investors.

Contrary to some pundits, I do not believe the lack of a hike somehow undermines the Federal Reserve’s credibility.  The world changes.  Recently, the IMF and other foreign entities indicated (pleaded) that a rate hike would significantly undermine efforts to repair their economies.  There will always be a crisis somewhere around the globe but not all of them have the same level of impact to the U.S. economy or the global economy.  The reality is, despite being the largest economy, the U.S. only represents about 5% of the global population.  Across the pond there is a European Union with 500+ million people — on top of all their issues they are now being forced to deal with a massive immigration emergency which will have a financial impact on their economy.

China represents about 20% of the world’s population and is going through what is, by most accounts, a significant reduction in their growth rate. Unlike five years ago, they are now the second largest economy in the world.  It seems perhaps the Fed is wise to take some time to see how China’s less experienced/untested  “management team” manages a slower growth rate or a potential looming crisis and how much impact that will have on the U.S. economy.  This issue was not as serious of a concern even 18 months ago.  However, as their dominos started to fall, it has quickly risen up the rankings of global issues as has the EU’s immigration issue.  The lack of action by the Fed is in part a recognition that there are times when consideration of activities outside our borders, even if our economy is doing ok, has to be weighed more heavily than at other times because ultimately that WILL affect the U.S. economy.  At this moment, the impact is not quantifiable, but clearly the Fed perceives the probability of these ex-U.S. issues having a significant negative impact on our economy as considerable.  As a large mature economy, like it or not, our economy is able to sustain dislocations better than others.  We should not expect any other sovereign nation or the IMF to act on our behalf.  However, we are the world’s reserve currency and I believe the Fed’s lack of a rate hike is in part a recognition of that reality. It is also a demonstration of ownership of a global leadership position.

All comments and questions are welcome.

Denise Farkas, CFA®