Finally, Clarity For The Fed

The future course of Federal Reserve monetary policy is becoming increasingly clear. Seemingly, all signs point to a rate hike following the December open market committee meeting.

Absent a surprise of greater-than-Brexit proportions, following the final debate the outcome of the US presidential election is virtually certain. Hillary Clinton is likely going to be the forty-fifth President of the United States, and her margin of victory looks to be substantial. This electoral result bodes well for a rate hike, as a Trump victory could have introduced a great deal of uncertainty into the economy and financial markets. Market volatility following a Trump victory could give the Fed Governors pause, as a rate hike on the heels of market turmoil could add risk to a what is, by historical standards, a fairly tepid economic recovery.

The Fed has a dual mandate to maximize employment and minimize inflation. With both of these criteria trending in the right direction, the timing and environment favor a rate hike.

Maximizing employment doesn't imply that the unemployment rate is zero. Economists recognize that there is frictional unemployment - a natural condition that arises in the labor market. In recent memory, the lowest unemployment rate of 3.9 percent was recorded in September of 2000. For the past several months, the unemployment rate has been holding steady at around five percent, exactly half where the rate stood in October of 2009 at the height of the financial crisis. That ten-percent rate is the peak unemployment rate for the past ten years. A somewhat complicating factor is that the labor force participation rate is also near a thirty-year low, but there are many causes for that result independent of monetary policy. While deconstructing all of the components of employment has never been simple, the headline trends suggest an employment rate approaching full employment for the Fed's purposes.

According to the U.S. Bureau of Labor Statistics, consumer prices in the United States rose 1.5 percent year-on-year in September of 2016, slightly higher than the 1.1 percent increase recorded in August. While historically low, it is the highest inflation rate recorded since October 2014. For comparison purposes, the average inflation rate since 1914 has been 3.3 percent. By moving well ahead of any sign of rampant inflation, the Fed can afford to make moderated adjustments instead of draconian ones, allowing the economy to absorb small rate increases over time.

The Fed won't move on rates in November because the meeting is a scant few days before the presidential election. The Fed can't afford to be accused of playing politics, even though some suggest that by not moving on rates now the Fed is, in fact, responding to the political environment. As the election outcome gains increasing clarity by the day and -- thankfully -- approaches the finish line, investors and the Fed will have a clearer path ahead as well.