What Are the Odds the Fed Will Go Too Far? | Chief Investment Officer

The Federal Reserve, which on Wednesday raised the federal funds rate for the second time in 2018, is feeling pretty good about the US economy near-term. So good, in fact, that it wants to do two more interest rate increases this year, up from just one originally envisioned. And likely three in 2019.

But such an ambitious schedule carries the risk of jacking up short-term rates too much, and choking off the economic recovery. Of the last nine recessions, all occurred as the Fed was in the midst of raising rates or recently had concluded a tightening drive, according to financial newsletter publisher Nigam Arora.

There may have been other primary causes, such as too many shaky mortgages, which produced the Great Recession, but the Fed was arguably part of the problem. The Fed’s robust three-year rate-hike campaign ended in 2006, about a year before the financial crisis and its attendant horrors.

That lesson resonates today. “The big concern is a Fed policy mistake,” said Dave Haviland, a managing partner at Beaumont Capital Management.

The nation’s economy looks healthy, at the moment. Fed Chairman Jerome Powell said after the rate raise that the economy is in “great shape.” The current expansion, at nine years, is the second-longest in US history, trailing only the 1991-2001 tech-boom era. As the expression goes, expansions don’t die of old age, and many indicators are very positive. Unemployment is at 3.8%, flirting with historical lows, and the Fed projects the number will fall to 3.5% by year end and 3.5% thereafter.

So if the Fed, which began raising rates in late 2015 from near-zero, carries out its intended program, the federal funds rate will be 3.25% to 3.5% at the end of 2019. That’s still lower than the peak of the last rate-increase regime, 5.25%. “If anything, I expect the Fed to increase the pace of tightening,” wrote Tyler Durden on the Zero Hedge financial analysis site.

If that’s the case, will the economy be equipped to handle it?

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