I had a terrible first car - a 1978 Honda Wagon. It came equipped with vinyl seats, a manual choke, AM Radio and was a shade of brown that resembled a very well-worn Buster Brown shoe from that time. Growing up in Montana, the 1978 Honda wagon also did not like to start in below zero weather. It required stomping on the gas several times and pulling out the manual choke as far as it would go. The Wagon had all of 60 horsepower which made driving up a hill or passing another car a tenuous endeavor and frequently required putting the gas pedal all the way to the floor. There was no difference in the Honda's power if the pedal was depressed completely to the floor versus let off a little. The same could be said for the Federal funds rate being effectively zero or .25 percent. There is not much difference in the impact on economic growth.
On Thursday, the Federal Reserve left the Fed funds rate unchanged, citing global growth concerns. Ultimately, this move seems to be more about the messaging to the markets rather than actually being impactful to economic growth. The Fed does not want to further upset the applecart given recent volatility in world markets by appearing too hawkish and therefore causing financial market participants to fear the Fed will tighten too aggressively.
The Fed funds rate is important as it is one of the tools the Federal Reserve has to stimulate or slow down the economy. Should there be an external shock that requires intervention, with short term interest rates at or near zero, the Federal Reserve has no "dry powder" to stimulate the economy. As such, the Federal Reserve is highly motivated to normalize interest rate policy to allow more flexibility should a crisis arise that requires them coming to the rescue.
With all the hand wringing around when the first rate hike since 2006 will occur, it is also important to remember that a rate increase is good news. It means that the economy is strong enough that the Federal Reserve wants to make certain that it does not get overheated. The labor market has finally healed from the financial crisis and our economy continues to grow.
Our Takeaways for the Week:
- Domestically our consumption driven economy is doing well with a strong labor market and inflation that is well in hand.
- Internationally, the economic uncertainty in China and resulting turbulence in emerging markets has caused the Fed to remain on hold