With rate hike, Fed gives itself some room

As a result of the economic collapse of 2008, the Federal Reserve Board dropped the interest rate on short-term treasuries to 0 percent. It remained at that level until Dec. 16, 2015. The Federal Reserve’s Open Market Committee vote was unanimous; all members of the board of governors voted for the increase. Chair Janet Yellen said in her news conference that the board’s future decision on interest rate hikes would be driven by economic results.

{mosads}Steven Wieting, the global chief strategist at Citi Private Bank, said last week that he’s actually concerned about the possibility of a recession in the next couple of years. He thinks that there is a 65 percent chance of a recession in 2016. J.P. Morgan economists Michael Feroli, Daniel Silver, Jesse Edgerton and Robert Mellman released a report in which they declared that “the probability of recession within three years” has risen to “an eye-catching 76 [percent].”

It seems odd that the private-sector strategists are looking for a recession in 2016, yet the Federal Reserve is increasing interest rates. The question is, why? With interest rates at zero, should the economy — as some think — go into recession in 2016, the Federal Reserve would have some ammunition to try and stimulate the economy out of recession. I do not subscribe to the philosophy that the Federal Reserve’s move was “one and done.” I personally believe that the Federal Reserve will make at least three additional moves in the first half of 2016. This would make the yield on 90-day treasuries around 1.25 percent.

The mandate of the Federal Reserve is twofold. First, to control inflation, and second, employment. The significant decline in the price of energy will risk the possibility of actual deflation over the next 12 months, so there is no reason for the Fed to increase interest rates to combat inflation. The second issue of employment is much more challenging — the recent labor and employment report show that 94.5 million Americans have given up looking for jobs, their unemployment benefits have ceased, and if they can find work, the income level is greatly reduced from what they had when they were employed full-time.

The formula for determining the unemployment rate does not include these people in the calculation, so when we say we have a 5 percent unemployment rate, that number is false. The Fed is telling us that we are approaching full employment when in fact nothing could be further from the truth. If we add back in the 94.5 million, the unemployment rate is approaching 11 percent. So again, with an 11 percent real unemployment rate, there is no reason to raise rates, so why are rates being raised? The answer is that the Fed wants to have some room before it ultimately has to go to negative interest rates similar to what we are seeing in Europe.

Currently, Germany has negative interest rates on its government debt out to five years maturity. If the stimulus through quantitative easing in Germany and other European nations does not produce the growth anticipated, it is certainly possible that negative interest rates could extend beyond five years. So is it possible that negative interest rates could be coming to America?

Yellen, as San Francisco Federal Reserve Bank president, said in a February 2010 speech that “Accommodative policy is appropriate, in my view, because the economy is operating well below its potential and inflation is undesirably low.” Later, she added that “If it were positive to take interest rates into negative territory, I would be voting for that.”

So, five years ago, the current chair of the Federal Reserve was thinking about the possibility of negative interest rates in the United States. By pushing interest rates up, it gives the Federal Reserve some room to operate to try and stimulate the economy. The Fed trying to stimulate the economy from the zero level of interest rates would be impossible; the Fed would have to immediately go to negative interest rates to try and save the economy.

It seems hard to believe that there is a possibility that we will have to pay the government to take our money. Today, a German investor who wants to buy a five-year bond with the payment of principal and interest guaranteed by the German government will lose money — they will get back less than what they put in at maturity right now. But if the current level of quantitative easing doesn’t work, then interest rates will go more negative in Germany.

Europe is struggling to get its economy growing again; China has seen four reductions in the value of its currency in 90 days and its economy is dropping. Many South American countries have hyperinflation. The global prospects are for a slowing global economy, and I do not believe America will be immune to the general global slowdown. So the chair of the Federal Reserve will use the 25 basis points bullets in her gun to try and stimulate the American economy. I’m afraid that the strategy would have worked better had the Fed begun loading its gun much sooner.

With the OPEC nations suffering significant economic hardship over the decline in the price of crude oil, they have had no choice but to sell assets in order to fund their budgets. My greatest fear is that low oil prices continue well into 2016 and will cause many nations to begin to liquidate their sovereign investment funds in order to feed their people. Vast amount of assets coming to the markets will depress market prices and, in turn, create the need for negative interest rates. I can find no example in tracking U.S. government interest rates of any extended period of time where interest rates were negative. We have just come through almost seven years of zero returns on short government securities; I wonder how Americans will respond to the idea of having to pay the government to take their money.

Perkins is a contributor to The Hill and DailySurge.com. He is the author of “The Brotherhood of the Red Nile” trilogy, a fictional account of radical Islamic nuclear terrorism against the United States.