September 25, 2017

The Federal Reserve is in a pickle. On one hand, it wants to raise rates at least once more in 2017. On the other, it wants to reduce its $4.5 trillion balance sheet. Such behavior often leads to a recession.

Is this too much shock to our less-than-stable economy?

Well, interest rates need to normalize. But the recovery to date has been weak for the most part, and do we want to cut that off? Probably not. As you can imagine, the rhetoric on both sides is amplified. The pro-rate-hike crowd wants an increase quickly so rates have room to go down in case of a recession. Others say the economy is too weak right now to absorb increased interest rates. For them, recession is the ultimate outcome of rate hikes.

Where does the Fed stand on this? We don’t really know.

In the July meeting, the takeaway was that a rate hike or balance sheet reduction could occur in the near future, but not at the same time. To throw a bit more spice in the mix, debt ceiling negotiations could take place during the Fed’s debate. And to really start cooking with gas, President Trump may have the opportunity to appoint five of the seven Fed board members during his first term.

Interesting times are ahead, there is no doubt about that. The results of this drama could play out for years.