Is the Fed correct in thinking rate hikes?

When the Fed finally lifted interest rates in the US for the first time in over a decade last year December the tone that was struck by the Fed was one of caution in its pursuit to normalise the interest rate cycle from an abnormally low rate for an extended period of time.  At the time I had written that although the Fed had envisioned to see its reference rate near 1.4% at the end of the year suggesting four rate hikes during the course of the year, it was highly unlikely that we would see that develop given the nature of the global economy as well as the converse pathway being followed by most of its developed counterparts.

The Fed didn't sideline this issue stating that the normalisation process would be taken in accord with the strength of the world economy knowing well that a steep climb in interest rates could destabilise the entire financial system. It's fair to assume that the Fed has stuck by its word by reconsidering a proposed hike in April saying that the outlook of the Chinese economy was waning on the global economy making it difficult for them to lift rates.

But yesterday the Fed's Minutes of Meetings for April were released showing that most FOMC members were ready to hike once again spooking the market into recess at the mere thought of it. The news came as somewhat of a surprise as many were expecting the hiking process to be further delayed to the first half of 2017.

Fed signals interest rate hike firmly on the table for June https://t.co/K25aq8kE1r pic.twitter.com/j2fe5xHXeM

— Reuters Top News (@Reuters) May 18, 2016

If it were to happen it would certainly set the trend for the divergence between developed nation's monetary policy which would indicate a departure from the current undertaking of economic coordination so as to insulate the world economy from shocks and place a concerted effort from all nations on finding a unified solution to economic hardship. A common theme that's cropped up often over the last while is the need to protect a nation's sovereignty giving further evidence that the economic pathway countries are about to endure upon requires solitary objectives as opposed to collective thought.

The move certainly provides short term relief for currencies such as the Japanese Yen that have suffered severely from policy mismatch with participates inflicting the opposite action the BOJ had expected them to after announcing an expanded and extensive stimulus program. The market has been unrelenting on countries engaging with negative interest rate policy with many warning the negative impact they will have if implemented.

This leads me to the first reason I believe the Fed isn't foolish in its decision to continue hiking rates as its escaped the trap of falling into the mindset of NIRP which could've thrown the US economy further into the abyss, instead relieving the reliance of the monetary policy by shifting economic policy decision towards fiscal decision makers. This issue has been spoken about from a number of institution who have said the functions of monetary policy have started to wear thin and the need for governments to restructure their economies a necessity.

Secondly the US economy although considered weak when looking back at previous years is much stronger relative to its peers currently, so when weighing up the pros and cons it would lean towards stabilising the economy rather than making it softer by delving deeper into negative territory with interest rates.  It's facing up to the headwind risk that's been created from abnormally low interest rates to be certain of normalised policy in the future, an aspect that doesn't feature at all in Europe and Japan.

If there were anyone that would be disappointed or despaired by the guidance it would be market participants who haven't adapted to this new way of economic cooperation or rather lack of. The sudden price moves that occur as a result of policy decoupling should be expected as the notion of paralleled policy enforcement no longer matches. It wouldn't be naive to think that such a move might aid the momentum of a new economic shock which I have no doubt, but we haven't reached a point where we can clearly assess the severity of such an event should it happen.

For now being aware of a changing tide is all that matters, its certainly going to make things interesting in the short term and more so over the long run.