Why things could be different this time around when the Fed raises rates

Fed Chair Janet Yellen and Vice Chairman Stanley Fischer used the Federal Reserve’s conference in Jackson Hole, Wyo., to prepare the world for at least one interest rate hike by year’s end.

“They feel the data is strong enough that they are on their way for the next rate hike,” said Ben Emons, chief economist and head of credit portfolio management at Intellectus Partners.

The world is a bit different now than in December 2015 when the Fed last raised rates, Emons postulated.

“Last year when they hiked rates, it had a very negative effect on markets because the dollar strengthens, the commodity markets fell, and that led to widening of credit spreads, particularly in the energy sector,” he said. “This time around, those dynamics [have changed]. So the question is how strong will the dollar become again as they hike rates and how would that have an impact on the global economy because the Federal Reserve these days cannot really hike anymore just based upon U.S. data. It has to focus on the global economy as well. The dollar plays an important role.”

Inflation will also weigh on the decision. Recently, San Francisco Fed President John Williams argued that 4% would be a good inflation target for the central bank rather than the current 2%. On Friday, Yellen said it was something the Fed would look into after more research.

“It suggests that they’re open to that idea to see what it really could mean for the U.S. economy in the future,” said Emons, who added that such a major change in a key target level could have consequences.

The savings rate would increase as people try to offset devaluing due to higher inflation and negative real interest rates. Emons noted, “That would lead to a lot of capital flows going around the world seeking more positive real returns and that will be quite impactful.”