Will the Fed Sink the Ship By Hiking?

The debate about the pace and timing of any further interest rate hikes by the Fed has been a primary focus of investors since the historic Brexit vote in late June.

Although some data has looked promising, other key pieces of data have been an outright letdown. Due to some of the mixed signals being seen in the data stream, Fed Funds futures have seen frequent changes and markets are currently pricing in only a small chance of a September rate hike. These contracts are, however, pointing to a good chance of a December rate hike-at least for now.

In a recent interview with Marketwatch.com, one Wall Street economist voiced his views that the world is awash in too many goods without enough demand.

Steve Ricchiuto, chief economist at Mizuho Securities USA, stated “Excess supply is a difficult problem to correct.”  In his opinion, oversupply causes prices to fall and drives a contraction in business investment and sub-par global growth.

Mr. Ricchiuto brings up several interesting points. China, for example, spent the last several years ramping up its production and manufacturing capabilities.

You could argue that the massive production potential has led to overproduction, and that with so much overproduction prices must fall further.

Unfortunately, this deflationary cycle is hard to overcome. As prices fall and business declines, so too does wages. As wages drop, consumers are less likely to spend-reinforcing the state of oversupply.

In the interview, Ricchiuto also added that “central banks are rapidly becoming powerless to correct the problem confronting most economies.”

Some business leaders appear to agree with Mr. Ricchiuto and some might argue that there are better ways to foster economic growth.

The problem, however, is the massive amount of debt accumulated in recent years.

The Fed has some difficult decisions to make, and while the central bank must consider the potential risk of the economy overheating, it must also consider the possible effects of tightening too soon.

A premature hike in rates could boost the dollar, taking a bite out of U.S. exports in the process. Such a decline in exports along with other possible effects of higher rates could potentially halt already less than stellar growth in its tracks.

Such a scenario could potentially drive the Fed to only lower rates again to fight economic recession.

Global growth is weak, and could potentially remain weak for some time to come. While all the talk of higher rates lately has stock investors on their toes, the reality is quite likely that rates are not going significantly higher any time soon. Even if rates do rise, they may do so only to decline again in the near future.

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