Must-Read: David Beckworth: Fed is Trapped in a Rate Hike Talk Cycle

Must-Read: Every member of the FOMC needs to read this carefully, and either agree with it or lay out an analytical case for why David Beckworth is wrong:

David Beckworth: The Fed is Trapped in a Rate Hike Talk Cycle:

Since mid-2014 the Fed has been talking up interest rate hikes… but only has a 25 basis point rate increase to show for it….

The Fed’s plans… bump up against unexpected economic developments… in a cycle that goes as follows: the Fed talks up interest rate hikes → bad economic news emerges → the Fed dials down its rate hike talk → good economic news emerges → repeat cycle….

Recall… this year. After the FOMC did its 25 basis point hike in December 2015, FOMC members were talking up four more rate hikes in 2016…. Concerns… about financial stress… dial back… incoming economic data was improving so… a rate hike at the June FOMC seemed possible. The rate hike rhetoric quickly changed, however, when the the awful May jobs report… Brexit….

Now the cycle is starting over. The gangbuster June employment report and strong retail sales… officials… increasingly “confident” they can raise rates in September…. It is almost inevitable, in my view, that this cycle will repeat…. First, much of the bad economic news that has caused the Fed to repeatedly dial back its rate hike talk has… been a byproduct of the rate hike rhetoric itself. Whenever the Fed talks up rate hikes it also talking up the value of the dollar which, in turn, creates a drag… because a large swath of the global economy has its currency linked to the dollar and because there is almost $10 trillion in dollar denominated debt issued outside the United States….

The second reason is that the Fed’s desire to raise interest rates is pushing up against the Tsunami forces behind the global race to the bottom of safe asset yields…. This downward march of interest rates has occurred prior to and after QE programs… is the result of far bigger global market forces…. As Tim Duy notes, the Fed is fighting against this force and is unlikely to win…. Interest rates are being suppressed by market forces despite the Fed’s best efforts. The Fed will not be able to raise interest rates this year and maybe even next year.

Now the Fed could still force up its target interest rate temporarily. But it would learn the hard way what the Riksbank in 2010 and the ECB in 2011 learned: getting ahead of the recovery and market forces will only make matters worse. In the case of the ECB… another recession for the Eurozone. Ultimately, interest rates cannot be exogenously pushed up. They have to be endogenously pulled up by a healthy economy. Until this happens, the Fed is trapped in a self-defeating rate hike talk cycle.