On August 25, with a worldwide audience of Fed watchers analyzing her every word, Federl Reserve Chair Janet Yellen raised the oddsfor a September 2016 interest rate increase. Yellen said, "In light of the continued solid performance of the labor market and our outlook for economic activity and inflation, I believe the case for an increase in the federal funds rate has strengthened in recent months." As the words rolled off her tongue, the Dow Jones Industrial Average turned tail and headed south. Once again, portfolios were bruised a bit by unhappy Fed talk.
Should the Fed raise rates? Some suggest that the Fed should do so now, so that the central bank can later cut rates to stimulate the economy when we have the next recession. But that sounds like a yo-yo talk. Let rates go up, so that we can enjoy watching them come down? What might Yellen be thinking?
We have pale GDP growth. The Commerce Department's second estimate for 2016's second quarter was just revised down from a chilly 1.2 percent annual growth rate to an even cooler 1.1 percent. With that, the year's first half is tallying less than 1 percent. But as Yellen indicates, labor markets are tightening, at least as measured by the conventional unemployment rate. As labor markets tighten and the number of individuals entering the labor force for the first time equals the number being hired, the economy reaches a point where, given the huge amount of available credit in the economy, tighter labor markets can lead to higher wages and inflation. But a recession? Not yet.