With a Rate Hike on the Horizon, the Fed needs to be Wary of Headline-Seeking Pols

This article was written with Jim Cahn, the Chief Investment Officer at Wealth Enhancement Group. It was part of a series of articles developed under an agreement with Forbes to work with a variety of contributors and assist them in delivering actionable investment ideas each week. The site forbes.com is one of the top 500 sites in the world with nearly 10 million subscribers and nearly 100 million page views a month.

While no one expects much out of this week’s FOMC meeting, Fed watchers will be reading signals from this meeting for clues as to when a rate hike will come. We’re also nervously awaiting politicians’ commentaries on the matter, especially as their discourse heats up under the backdrop of the 2016 presidential nomination.

Earlier this month, Janet Yellen went to Capitol Hill and told lawmakers what the Fed has consistently communicated publicly for weeks: A rate hike is on its way. While she wouldn’t say exactly when the next increase will come, she was pretty clear that barring an unexpected turn it will happen at some point this year. This represents a common-sense, level-headed approach.

While there, however, she was harangued by several lawmakers from both sides of the aisle, including Rep. Sean Duffy (R- WI), who questioned the Fed’s openness and transparency regarding a recent leak investigation. And while Representative Duffy’s concerns may have been genuine, it’s more likely that this was less about policy and more about politics. It’s hard sometimes to turn down the opportunity to spar with a well-known figure on a big stage.

As we saw on July 18th, with Donald Trump’s incendiary comments about John McCain’s war record, politicians – or would-be politicians – will say just about anything to please the partisans or get their name in the headlines. And excluding perhaps these most recent remarks by Trump, such rhetoric is ultimately harmless, even as many find it distasteful. (A more cynical read: Far from merely harmless, incendiary rhetoric is effective. Indeed, vote-hungry politicos engage in it because it works, as Mike Huckabee has recently learned with his comments about the Iran nuclear deal).

But monetary policy is one instance where words do matter. They do have an impact. The Fed cannot become embroiled in the overheated political rhetoric of the day. Ms. Yellen has said in the past that the Fed operates best as an independent agency, and she’s right.

That’s not to say the Fed is above reproach. It’s not. Dissent is good. Opposing viewpoints are good.

But the Duffy-Yellen episode that we saw was not an honest debate. It was political caterwauling. It’s unnecessary noise that could potentially distract the Fed and keep it from fulfilling its mission of keeping the nascent economic recovery on track. When and if they should raise rates are tough decisions, something most politicians are loath to make.

Politics aside, there is little question that the Fed is currently charting the most prudent path. A modest increase over the next few quarters makes the most sense. And if the economy is able to absorb it, more gradual increases should follow.

Recent events have only crystallized this outlook. Greece finally agreed to a deal with its creditors to avoid another bailout and a potentially messy exit from the Eurozone. And China, which seemed headed for a market collapse a couple weeks ago and continues to suffer from headline-making volatility, needs to be put in context. Stocks in China were up almost 150% over the past 18 months, and even year-to-date, they’re still up over 13%.

Closer to home, trouble spots remain for sure. Inflation is stubbornly low, having been beneath the Fed’s preferred rate of 2 percent for more than three years. Wages have also flat lined. Until such measures improve, a broader recovery will likely fail to materialize.

At the same time, other metrics have been strong. The labor market, thanks to steady job creation, is nearing what the Fed believes is full employment. Housing data has been encouraging, punctuated by a rebound in existing-home sales. And even recent spending and consumer price index readings suggest there could be upward pressure on inflation and wages soon.

For the markets, this will likely mean more of the same. The outsized gains of the past few years might be a distant memory, but investors will likely continue to flock to equities as fixed-income solutions will struggle to even produce anything but nominal returns. This is what has happened during past tightening cycles, when stocks have performed relatively well, thanks to earnings growth offsetting the lure of higher yields in short-term bonds. In short, investors will have to continue to take risks as they seek to earn returns.

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