Fed in a Box

While pundits debate the timing of the US Federal Reserve’s first interest rate increase of the decade, what’s certain is the Fed Funds rate path higher will prove a slow climb.  Why? In large part, owing to US Dollar strength in the last twelve months.

Unlike past business cycles, the Fed’s motivation now is driven neither by rising inflation nor an over-heated US economy. Indeed, popular inflation measures remain well below the Fed’s 2% threshold, commodities have collapsed, and US GDP real growth is merely 2+%.

Instead, the upcoming Fed action will begin the scrapping of a  7 year old economic stimulant—Zero Interest Rate Policy (ZIRP)—with the Fed reclaiming a key policy tool in their arsenal.  The goal is for short term rates to revert eventually and reflect true market conditions.

So, the Fed wants their tool back but not at the expense of dampening economic growth. The fly in the ointment is the US Dollar (USD) as its 20% appreciation (versus a basket of key currencies) has acted to slow   economic growth and help stall corporate profits growth. Example? Apple recently estimated USD strength reduced iphone revenue by $24 per unit. My calculator suggests the revenue loss was in excess of $1 billion –in one quarter!

Considering our strengthening currency, raising interest rates in a flurry of moves over a short time period punishes debtors and the combination risks derailing our fragile growth trend. The reclamation will take longer than previous rate cycles suggest.  To nurse economic growth, we expect the Fed to move glacially to normalize rates.

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