A humiliating day awaits the Federal Reserve

By John Crudele

January 28, 2016                                                                                                                    

 

Modal Trigger  

The Commerce Department, at 8:30 a.m. Jan. 29, will announce how healthy the US economy was in the fourth quarter — and the answer is expected to be “not so good.”

In fact, according to the Atlanta Federal Reserve Bank, the nation’s economy, or gross domestic product, grew at just a 0.7 percent annual rate in the final three months of 2015.

That’s not the official number — the official one will come on Friday from Commerce. The Atlanta Fed keeps running tabs on what the number should be, based on data already in circulation. They call it GDPNow and, so far, it has been pretty accurate.

Some Wall Street economists have GDP forecasts that are even lower, much lower — like negative numbers lower.

So why will the Fed be embarrassed?

Because just last month, it raised interest rates despite the fact that it was quite clear that the economy was slowing. In fact, the Atlanta Fed’s GDPNow model back in December wasn’t much higher than it is now.

The Fed on Wednesday, following its January meeting, said it would keep interest rates right where they are. That is, no hike or cut.

But already, it’s acknowledging that the US economy is slowing. Friday’s GDP should be a whack across the face since the rate hike was so recent.

Stock prices fell sharply after the announcement, because the Fed said nice things about the labor market — something it will probably regret in less than a week — and because there seems to be more concern about inflation, which could prompt more rate hikes.

Higher interest rates, of course, tend to slow down an economy. And to raise them when business conditions are noticeably weak — as they were at the end of 2015 — is an obvious mistake.

In fact, the Dow Jones industrial average is down 9.1 percent since the day before the Dec. 16 Fed rate hike. Either the markets don’t like the hike, or the economy is cooling and profits are falling — taking stock prices with them — or both.

I’ve already explained that the Fed felt that it needed to raise interest rates for a number of reasons that I can’t disagree with. For one thing, the quarter-percentage-point hike in December from the long-standing near-zero rates gives the Fed an opportunity down the road to lower rates when the economy starts weakening.

The second reason is that savers have been getting killed by the ultra-low rates, and I think that even the Fed now realizes that this unusual policy has been a disaster.

But a couple of things have happened since the December hike. The first is that interest rates really didn’t go up. The so-called “discount rate” did — that’s the rate banks charge each other for overnight loans — and so, too, did the irrelevant prime rate.

But interest rates in the open market have actually gone down because traders realize that the world economy is a mess and that borrowers will need to be incentivized to borrow through low rates.

After Friday’s GDP number, there will be the usual defenders and detractors. The defenders, mostly Wall Street pros, will argue that economic growth slowed because (1) the weather in the US was warmer than normal and (2) China’s slowing growth hurt US companies.

If the GDP on Friday comes in lighter than expected, you’ll start hearing two things. There will be howls first that the US is going into a recession and, second, that the Fed needs to do something.

The calls for the Fed to “do something” will get louder if the stock market continues its abysmal performance — down 8.5 percent this year.

What can the Fed do? As I said above, it could take back the quarter-point rate hike it instituted in December, even if that will make Chair Janet Yellen and her policymaking committee look foolish. More likely, the members of the committee will start reassuring the markets that another rate hike won’t be happening until later than expected.

Wall Street has been expecting another rate hike in March, but that time­table now seems to have gone away. I’ve been saying that the next hike won’t be until summer, and that’s what the experts now seem to expect.

Since I’ve been right, I’ll tell you what I think: The Fed will be given an opportunity to hike rates come June because it’ll get some misleadingly good economic numbers this spring — as it always does.

Whether the Fed uses that opportunity to raise rates will depend a lot on how it thinks the financial markets will react.

Right now, I’d guess there won’t be another hike this year — especially since a move like that might be awkward in a presidential election year.

As exciting as this Friday will be for the financial market, next week will be even more so. On Feb. 5, the Labor Department will release its January employment report.

The December report showed an exceptionally large gain of 292,000 jobs.

I revealed in a previous column that almost all that growth came from seasonal adjustments and the real gains were 11,000. Still, the 292,000 is the only justification left for the Fed’s actions in December.

A lousy employment report next week will put the Fed in a whole new kind of trouble. I won’t get into it now, but January jobs reports like the one coming next week are often disappointing because of some statistical quirks in the numbers.

If this Friday’s GDP report elicits an “Oops” at the Fed, next Friday’s could result in a lot of “Oh, s–t!”