Bracing for the Bernanke Put

The FOMC decision on interest rates is expected today at or around 2:15 PM EST.  Most market pundits are expecting no change to the Fed Funds Rate.  The target of 0.00% to 0.25% is still being maintained as consensus.  Today’s focus is likely going to be on how many more Fed governors are wanting to see rate hikes come into play as well as its exit strategy for its balance sheet assets.  The last FOMC had only 1 calling for a hike, some feel there could be two calling for a hike today.  It seems unlikely that Bernanke and friends can turn on a dime just yet, but the FOMC should be raising rates today.

It seems that very few actually believe that the real unemployment rate has changed or really improved as the data from the Labor Department has shown in recent months.  It is believing in that “opting out of the workforce” issue as if everyone who couldn’t find work went to a permanent retreat at the Zen monastery or just all took on the house-spouse role permanently.

What is interesting is that Bloomberg noted “there is a possibility that the Board could announce another 25 basis point increase in the discount rate….” and noted that the current 50 basis point spread between the discount rate and the fed funds rate compares to what is traditionally 100 basis points.

Whether the FOMC changes the discount rate or not, the Fed needs to begin hiking rates.  Even if this is just setting at 0.25% rather than the virtual-zero rate we have today, this would be a start.  That is no signal at all that things are overheating.  In that regard, Fed Funds of 2% to 3% used to sound exceptionally low in the 1990s.

There is an interesting notion here that is not being talked about.  Hiking the Fed Funds now would probably have a very small impact.  This would actually give the Federal Reserve some ammunition next year if we end up in a double-dip recession after the tax rate resets are likely to come back into play.

The FOMC can rarely get away with a rate hike and then have to turn right around with a rate cut.  But getting at least one of the incremental hikes today would get us closer to a normalized interest rate structure.  Imagine if the FOMC just leaves rates here with no changes at all and we do end up getting a double-dip recession.  At that point the Fed would not even have the classic tool of cutting rates to ease the burden.  Then the Fed will get to start considering asset purchases all over again.

Isn’t the market looking for a continued ‘Fed Exit Strategy’?  If the Fed doesn’t start hiking rates soon, the exit strategy could ironically have to be put off indefinitely.

There are literally hundreds of other opinions here.  Many want rates kept here until unemployment really improves rather than just gets less-bad or improves nominally.  Many want the yield curve steep for the banks to be able to stay healthy as they try to get off the government dime and as they try to remain profitable from operations.  And no one wants the consumer to face much higher interest rates.

Hiking rates now would at least allow for rate cuts ahead if things start to weaken again or if we do get the double-dip recession scenario.  Still, the odds of a rate hike today are almost nil.  The most recent Fed Fund Futures data from the CME does not even really get the implied Funds rate to 0.25% until July and an implied 0.50% is not likely until November or December.

JON C. OGG