World Bank Offers Clue as to Why the Fed May Delay Raising Interest Rates

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In a move that, in terms of shock value, was almost as sensational as the revelation that not all politicians are honest and trustworthy, the chief economist for The World Bank yesterday called for the Federal Reserve to delay raising interest rates until next year. The reason this plea is so un-shocking is obvious from the rest of the linked to Reuters article. The economist, Kaushik Basu, was speaking in response to The World Bank cutting their forecast for global economic growth for this year from 3 percent to 2.8 percent. As a result, said Basu, The World Bank “…switched on the seatbelt sign” for developing economies.

Lest we forget, economists, just like politicians, often have an agenda when they make pronouncements. The effects of the Fed’s actions on developing nations are the concern of a World Bank economist, almost by definition; the question is, should it be a concern of the Fed themselves? In theory, the obvious answer to that question is no. The Fed has a dual mandate, to control inflation and unemployment, but their concern is solely the U.S. economy, not the prosperity of developing nations. In reality, however, those two things are inextricably linked. In case it has escaped your attention we live in a global economy, where ripples from one area can rapidly disrupt the tranquility of another. If, therefore, you believe that the Fed’s board is looking for an excuse not to disturb the status quo, this development may be more significant than it at first appears.

There are plenty of reasons to believe that that could be true. Those who doubted the wisdom of ever embarking upon the emergency measures adopted in response to the recession, a Zero Interest Rate Policy (ZIRP) and QE, have gone remarkably quiet for one basic reason…the policies worked. The recovery has been slow, certainly, but compared to Europe, where QE was resisted, fairly smooth. The rampant inflation that many predicted has yet to materialize and, while the long term effects of market distortion remain to be seen, there is no immediate sign of any detrimental effects of the policies. The Fed is faced with the age old problem…why fix what isn’t broken?

In addition we should bear in mind that Fed Chair Janet Yellen inherited this situation. I have no doubt that Dr. Yellen is motivated solely by what is best for the country, but at the back of her mind must be that if she were to act too soon and disrupt the recovery it would be seen as her ruining the good work of her predecessor. Delaying action may risk a little more inflation than desirable at some point in the future but when that risk is weighed against disrupting the recovery here, and as a consequence harming the world economy, it doesn’t seem too bad. The Fed is aware of that risk, as they have stated many times, but always with the caveat that any decision will be data driven.

With what was evidently a weak first quarter still a recent memory and now with a warning that raising rates before next year could do harm to the global growth that is so important to the U.S. economy, delaying a difficult decision must be looking increasingly attractive to the more dovish elements of the Fed’s board.

These things have certainly conspired to change my view. I had previously agreed with the consensus that a September rate hike, albeit a small one, was a certainty, but I am beginning to question that. A delay until at least the end of this year while citing the World Bank concerns (among other things) could be looking increasingly attractive to the board.

Even the chance of that happening opens up several short term opportunities for trades. The markets in general and the bond market in particular, have already priced in a 25 basis point hike next quarter and the promise of entering a period of gradually rising rates. If such a move and intention are announced, therefore, the reaction will be fairly muted, limiting the potential loss of positioning against the conventional wisdom. If, on the other hand, the Fed does succumb to temptation and delays further, short term yields will drop dramatically and stocks will fly as all of those wrong positions are unwound.

Basu’s comments may initially appear like just another economist talking their book, but they just may give the Fred another excuse to delay. Positioning for that possibility over the next couple of months is looking like an increasingly smart thing to do.

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.

Martin Tillier

Martin Tillier spent years working in the Foreign Exchange market, which required an in-depth understanding of both the world’s markets and psychology and techniques of traders. In 2002, Martin left the markets, moved to the U.S., and opened a successful wine store, but the lure of the financial world proved too strong, leading Martin to join a major firm as financial advisor.

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