Credit: 
As the December 16 FOMC decision is only one month away the Fed faces a dilemma as it looks to start normalizing rates. Assuming the Fed raises rates, it will not only be the first central bank to hike but it comes at a time when others, specifically the ECB, are moving in the opposite direction. The dilemma is the monetary policy divergence and a US dollar that is heading higher.
Why is this a Dilemma?
It is not a dilemma for other central banks as a firmer dollar reduces some of the pressure to ease as a weaker currency is effectively a way to loosen monetary conditions. It is a dilemma for the Fed as a stronger dollar weighs on commodity prices and depresses import prices, which makes it more difficult for the central bank to achieve its goal of pushing inflation back to 2% as part of its dual mandate. A strong dollar can also weigh on stock prices as multinational company earnings get impacted and lower commodity prices, specifically energy, hit shares as well.
So the Fed seems stuck between a rock and a hard place. It desperately wants to start the normalization process but the divergence with other central banks means it is going it alone. This risks pushing the dollar even higher and to the point where it will not only impact the economy but make it difficult to achieve its inflation goals. What this suggests is the Fed will go out of its way to sound dovish assuming it hikes rates in December by emphasizing the normalization process will be a gradual one.
What Could Derail the Fed and Ease its Dilemma?
The bar has been set low for a rate hike with a minority in the market seeing a chance the Fed will stay pat on rates (Fed Funds futures show current odds are 70/30 in favor of a rate hike). The potential impact on the dollar is likely to be a consideration as it poses a dilemma for the Fed but not to the extent that it would sway the vote. It would take a lot more to shift the Fed from raising rates on December 16, such as a sharp deterioration in the November employment report (due Dec 4) and/or an escalation of terrorism that would impact the economy. So while there are obstacles that could shift the risk away from a rate hike, the value of the dollar is not likely to be the deciding factor although it could influence the pace of normalization going forwards.
Jay Meisler, founder
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
