Fed Rate Hikes May Create Self-Fulfilling Prophecy

The Federal Reserve announced another quarter-point hike yesterday, following the same move in December. The increase brings the federal funds rate into a range of 0.75 percent to 1 percent.

The Fed said its decision was based on both realized and expected labor market conditions and inflation. Translation: the labor market has tightened to nearly full employment and inflation is finally starting to tick up after years of dormancy.

But beware: there have been 13 Fed rate-hike cycles in the post-WWII era, and 10 landed the economy in recession, according to David Rosenberg, Chief Economist & Strategist, Gluskin Sheff.

The current economic expansion, which began in June 2009, has now entered its 93rd month, surpassing the 92-month expansion of the 1980s. That makes this the third-longest in U.S. history. In records dating back to before the Civil War, only the expansions of the 1990s ('91-'01) and 1960s ('61-'69) were longer.

Throughout U.S. history, the gap between one recession’s end and the next one’s beginning has averaged just under five years. In other words, this expansion is getting really long in the tooth, which is a very uncomfortable reality.

The Fed is playing a very risky game by raising rates right now, with the belief that this expansion will go on indefinitely. It won’t. We are currently in the midst of concurrent stock, bond and housing bubbles, and all bubbles eventually burst. All of them.

The economy surely doesn’t look all that strong at present.

The Atlanta Fed just relowered its Q1 GDP estimate to 0.9 percent from 1.2 percent after seeing the BLS report Friday, as well as consumer spending and CPI data.

Real GDP increased 1.6 percent in 2016, compared with an increase of 2.6 percent in 2015. In other words, the Fed is tightening into an economic slowdown.

The strong dollar is constraining exports, which creates a drag on GDP. Last year the trade deficit once again eclipsed $500 billion, as it has for 12 consecutive years.

Federal Open Market Committee members say they expect to make two more hikes in 2017 and three in 2018.

However, continued rate increases during this time of economic weakness will likely be counterproductive. Don’t be surprised if/when the Fed is forced to reverse course and slash rates once again as the economy stalls or the next recession inevitably begins.

But in order to cut rates in the future, the Fed first had to raise the funds rate above zero, which it started to do in Dec. 2015. Now it at least has some breathing room when trouble eventually rears its ugly head once again.

That’s what this and the two previous rate hikes (in Dec. 2015 and Dec. 2016) were all about. However, they run the risk of creating a self-fulfilling prophecy.

In essence, these hikes could spur the very recession or economic crisis the Fed says it is guarding against. That would be the definition of irony.