Weekly Market Outlook

Why a Fed Interest Rate Boost Probably Will Wait Until December

Moving before the election exposes the central bank to political fire. Odds are strong that the Federal Reserve will wait until after the election to hike short-term interest rates. One big reason: to avoid taking heat in the middle of a brutal presidential political contest.

The economic impact of a 0.25 percentage point raise likely would be small. But the symbolic importance of an increase would be significant. “They don’t want to cause a ripple before the election,” says James Lockhart, vice chairman of investment firm W.L. Ross & Co.

The candidates would be tempted to condemn or praise an increase, thus putting the central bank — which likes to be seen as above the partisan fray — in an uncomfortable place. “The Fed doesn’t want to be accused of playing politics,” says Brian Milligan, portfolio manager of the Ave Maria Growth Fund AVEGX -0.25% .

On Friday morning, the politicians, the market, and everyone else will be eyeing Fed Chair Janet Yellen when she speaks at the Jackson Hole conference of central bankers in Wyoming. Few expect her to clearly signal when the Fed will act. She lately has only said the decision will be “data driven,” which means it hinges on the economy’s prospects. That leaves everyone in suspense.

The highest chances for an increase are for the December meeting, at 40%, according to the CME Group’s Fed Watch tool, which charts futures contracts on the Fed’s moves.

Only 10% believe that the Fed’s policymaking body will pull the trigger at its next gathering, Sept. 20-21, and 23% say November (there is no October meeting). A Wall Street Journal survey of 62 economists found that 71% expect the Fed to wait until December.

The Fed could be a political target because it is the lone major player in the stimulus game. With Washington divided between a GOP-controlled Congress and a Democratic-run White House, ratcheting up economic stimulus through bigger government spending is a non-starter.

So the task of solo stimulator has fallen to the central bank, through lower rates (meant to spur economic activity, courtesy of lower borrowing costs) and, for a time, buying bonds (which also held down rates and injected money into the system).

Yellen has given no indication whether she wants a second four-year term once her current one ends in January 2018. It’s unclear whether Democratic presidential nominee Hillary Clinton would reappoint Yellen, although Clinton’s old boss and staunch supporter, President Barack Obama, named Yellen to the post.

Republican candidate Donald Trump has said he would not give Yellen a second term, citing her Democratic affiliation and her inclination to push up rates, which he argues would boost the dollar and harm the competitiveness of U.S. exports. In Congress, some lawmakers are pushing for what they call an “audit” of the Fed, which some view as a way to bend the central bank to Congress’ will.

In her June press conference, Yellen pooh-poohed the notion that the election would have any affect on rate-making decisions. “We are very focused on assessing the economic outlook and making changes that are appropriate without taking politics into account,” she said then.

“I don’t think anyone in the room believed her,” noted economist Hugh Johnson, chairman of Hugh Johnson Advisors.

What the Fed’s move means for you

How would a Fed move affect investors and Americans in general? The market nudged up a bit after the Fed’s last move, also a quarter point, last December. That’s because the increase was well-telegraphed, so no one as surprised, and the market viewed the action as a positive sign — the Fed thought the economic recovery strong enough to swallow higher rates.

Higher short-term rates don’t immediately impact longer-term loans such as for homes and cars. Still, eventually high short rates seep into the longer end of the credit market.

What no one doubts is that the Fed overall wants to raise rates, at some point. “It makes sense to get back to a pace of gradual rate increases sooner rather than later,” Fed Vice Chair Stanley Fischer said Aug. 18 in Anchorage, Alaska.

How much and when are the big unknowns. It wants to lift rates to ensure that inflation doesn’t climb too swiftly, which is not a problem at the moment, with the Consumer Price Index below 2% yearly growth, the Fed’s target of an ideal tempo.

But the Fed also wants sufficient ammunition for the day when a recession occurs. Then, its principal weapon to fight the downturn would be lowering interest rates, which it can’t do when they already are low. Until the Fed boosted them last December, rates had been near zero. Previously, the last time the Fed raised rates was 2006.

Of course, the risk is that higher rates will throttle the anemic seven-year economic recovery. That’s the chief factor preventing the Fed from increasing rates more robustly in the recent past.