The Hawkish Rate Hike Call Gets Even More Hawkish

The FOMC should be raising the Fed Funds Rate from the 0.00% to 0.25% benchmark it has up to 1% by the end of summer.  That is what the hawkish Thomas Hoenig, President of the Kansas City Federal Reserve, is calling for today in a meeting hosted by the Bartlesville, Oklahoma Chamber of Commerce.  Hoenig has been the standout vote for rate policy hikes.  In a speech today in Oklahoma, Hoenig argued that the U.S. economy has the momentum to sustain itself even with the recent troubles in Europe.

Hoenig has noted that the perpetual “extended period” language limited the Federal Reserve’s flexibility to begin raising rates modestly.  What is more interesting than the 1.00% notion is that Hoening believes that rates, after a pause at 1% to assess the impact, could go as high as 3.50% to 4.50%.

Hoenig noted improved market conditions and liquidity, as well as an improving outlook.  He also called the recovery more broad-based and self-sustaining and said that the recovery could be stronger than anticipated.  Consumer spending was also noted as having expanded at a solid pace at the same time that business spending on equipment and software has been rather strong.

As far as unemployment is concerned, Hoenig noted that the process of job creation is taking hold and that large jobs added in the coming months will cause the Fed to lower its unemployment projections ahead.

Our take on this is that this near-zero rate policy, if kept on too long, will only remove the option for the FOMC to act the next time there is trouble brewing in the economy.  What is left when they won’t lower reserve requirements and cannot lower rates?  Some options, but not as fast and easy and effective.  A rate hike will also flush that dollar carry-trade out of the system as well where investors can borrow at almost nothing and can use leverage to make far higher spreads for returns.

A second take is that if rates are at 3.50% to 4.50% on short-term rates, then we have either entered into a robust return of the economy again or that we have entered into the inflation age.  Or both.

American’s better hope that Hoenig is off base and not ever in control of the FOMC any time soon.  With our national debt having crossed the $13 trillion mark, try doing the math on just the interest that the government has to pay with an average Treasury yield running 4% or higher rather than 2% or under.

JON C. OGG