To Raise or Not to Raise; Ahhh that…

…is indeed the question.

This week everyone in the economic and finance world is fixated on one thing. It isn’t China. It’s the Fed meeting tomorrow announcing the decision to hold or raise interest rates. It’s a pretty big decision in the business world. But not as important as playing and spending time with your little baby boy of girl in the real world.

I provide my color on what I think the Fed will do at the end of this blog, but it’s far from a certain thing.

The backdrop of all of this, of course, is that we’ve had 7 years of zero rates. It’s unprecedented. There is soooo much fear that even the slightest hiccup will destabilize whatever recovery we’ve had thus far. But the obvious question this begs is, if the economy is really this fragile – after 7 years of record corporate profits, record stock market gains, and unemployment near the full employment at 5.1% – then when can we ever return to normal? How do you expect consumers to feel any confidence when you’re constantly sending the message, we can’t leave zero rates and free money because the economy and recovery are too feeble. Seriously? If a 0.25% rate hike is capable of sending our economic recovery into a tailspin, then we need to re-evaluate whether or not it was much of a true recovery. Or if it was all just a facade; a house of cards built on free and easy unlimited money.

The critics seem to already answer my question. They refute their own claims that we have a robust recovery. They throw all the economic statistics and impressive stats right out the window.

Given the statistical measure of the economy, if at this point we can’t absorb a simple quarter percent increase, then we will never be able to. Even 5 more years down the road. And all the gains are nothing more than smoke and mirrors.

You can’t in one sentence boast about how robust employment and the economy is. And in the next sentence cower and frighten everyone by saying, “but things are still very fragile…” Reminds me of the one-armed economist I wrote about in an earlier blog.

The parallels to 1937, during the Great Depression, are uncanny. In 1937, the Fed began to tighten. Like today, the markets had increased substantially And people thought we had escaped the wrath of economic doom. The Fed actions precipitated a regression and downward spiral into the depths of the depression.

But the question nobody ever asks is, was it the Fed actions, or was this just an inevitability all along – regardless of the route or path, the destiny was preordained; there is a price to be paid and a pain that must be endured when we enjoy the gains of untethered greed.

There was a movie once, I think either the Final Destination series or horror films or a some other Sci-Fi movie, I can’t remember. Anyway the movie is about can we alter the future based on the consequences of our actions. Or once the actions are committed, is the ripple effect and path already defined – regardless of which path or temporary escape we enjoy.

My answer is simple. There is nothing truly free in this world, except what God and nature gives us. And every sin, greedy self-indulgence, and irrational exuberance must one day be repaid.

Zero rates. Unlimited free money printing. Unlimited debt. None of these things are truly free or without consequence. There is always a price to be paid.

Nothing in this entire universe is unbounded. Every system is bounded and has limits, reigned in by consequences and reactions.

If you think zero rates forever or unlimited QE and money printing or skyrocketing government and private debt can go on forever without severe negative repercussions, you might as well get that lobotomy – because you’re already brain dead.

The markets will roar if the Fed holds rates. The markets will swoon and the dollar will rise appreciably if they increase rates. But my opinion is that it doesn’t really matter what they do. The intermediate term trend is still down. And the repayment of pain, the due date for the proverbial “loan” approaches faster and with more ferocity the longer we stay where we are.

So, what’s my actual opinion on what happens Thursday?  I think 60% chance they raise rates. The markets are evenly split with a negative disposition. But it could go either way. I’m leaning towards an increase.

The Fed already lost crecredibility once when they set the unemployment target to raise rates. After it hit that target, they looked like fools when they lowered it again. It’s hit their target again, at 5.1% unemployment. It’s historically quite low, near full employment, as economists say.

But the Fed has two mandates: moderate inflation and maintain full employment. They’ve achieved one.

Inflation is a bugger. They want to get inflation higher towards their nominal 2% target. But the collapse of oil prices and commodities and strengthening dollar have pushed inflation pressure downward. But on the other hand, the strong employment figures is sure to drive wage pressure higher and the Fed knows this. Wages are the biggest component of cost and inflation.

Janet Yellen, the Fed chairman, has previously said that it isn’t the exact 2% target they’re looking for, but the clear sign that inflation is headed toward their goal. In other words, she’s looking at wage growth more so than unemployment.

So I decided to dig and do my own research today. I looked up the BLS government agency that reports on employment and wage date. I read through the raw data instead of relying on press and media reports. And here’s what I found (I attached the full report as reference):

BLS Employment Report

I discovered 2 very important but curious discoveries which I haven’t found anyone in the media reporting about. If the Fed is true to their word, they must also be taking note of these facts as well.

1. Wages are increasing faster than expected. Wage pressure is indeed bubbling up. It’s not a surprise because company after company has reiterated how hard it is getting to hire qualified workers, and that they’re having to pay more for them. There is a growing competition for workers. My second discovery and point will explain why.

In August, the wage growth grew faster than the previous two months. In June and July, wages grew 0.2% month to month. In August it increased substantially to 0.4%, or double the previous rate.

Furthermore, there are two components of wage growth: hourly earnings increases and hours worked.  Last month the hours worked also increased by 0.1 hours. The previous two months had been no change. This has two implications. First, this is a leading indicator for faster wage growth. And second, the effective wage growth per worker actually increased by an additional 0.29%.

So the effective wage increase in August was 0.7%. This is really enormous. And should worry the Fed.

2. The unemployment rate at 5.1% is misleading. Businesses care only about hirable or qualified workers. Based on the BLS report I noticed the backlog of long term unemployed is static. It’s not going down, where as the short term unemployed is going down rapidly.

There are 2.2 million long term unemployed, defined as 6 months or longer (most likely these people need retraining to adapt to evolving economy and jobs). This number hasn’t been moving at all over the past several months. If I subtract out this number from the overall, I get a hirable or effective unemployment figure of 3.7%. This is very low, which is certain to drive wage inflation substantially in the near term as competition for workers intensifies.

(I’m just analysing this as a business person or hiring manager would.)

So based on my independent analysis, I have to conclude that both conditions of the Fed have been met – if I take Yellen’s words at face value.

Given China and international market turmoil has stabilized somewhat.  And the dollar has stabilized. I believe the Fed – based on data – should increase rates Thursday.

Based purely data, I would say it’s virtually a certainty they will raise rates.

However, we know that their decision isn’t guided by pure data (as it should be), they are driven by fear more so it seems. They are terrified of making a mistake. And frankly, I don’t believe a word they say anymore. They’ve lost all credibility in my mind.

So taking that into context, I reduced my probability of a rate hike to only 60%.

Independent of all of this analysis, the Fed should have raised rates long ago. I’ve made it clear that zero rates are toxic and bad policy in general.