The Fed could have a surprise in store for Wall Street

The Fed could have a surprise in store for Wall Street

Wall Street is wondering whether there will be three or four interest rate hikes this year. After Friday’s strong employment report for February, four seems to now be the odds-on favorite.

I’m going to be a troublemaker and suggest something else: If the Federal Reserve is truly worried about an overheating economy and future inflation, then there are some shocking steps it could take that won’t make the stock market or the Trump administration happy.

I’m not saying this is going to happen — I am just saying that it could happen.

I will get back to this in a minute, but let’s start at the beginning. The Fed has been raising rates gradually since December 2015. In all, there have been five tiny hikes of one-quarter percentage point each.

Hikes six, seven, eight and nine could come in 2018, starting with the Fed’s March 21-22 meeting.

The Fed is concerned not only with inflation as you and I know it — meaning, a rise in prices — but it is also clearly worried about asset inflation.

What’s that?

Alan Greenspan, who did virtually nothing right when he was head of the Fed in the 1990s, did get this correct when he commented that there was “irrational exuberance” in the stock market.

Greenspan was worried about asset inflation — a stock market that was climbing without justification during the dot-com mania.

If the ’90s stock market was exuberant, today’s Wall Street bubble is super-duper exuberant.

So not only is the Fed, now headed by Jerry Powell, worried about prices, but also about asset valuations that are getting out of hand.

The Dow Jones industrial average jumped more than 400 points after Friday’s jobs report. But the market you should be looking at is the bond market — and that market hasn’t been happy with the alleged strength of the economy lately.

There’s an old saying in the financial community that it’s the Fed’s job to pull the punch bowl away when the party gets out of hand. So how could Powell’s Fed keep Wall Street from getting more inebriated?

The most shocking thing would be to raise interest rates between its official meetings. After the meeting next week, the Fed doesn’t have another policy-making Open Market Committee meeting until early May.

A surprise rate hike in April would slap some sense back into investors.

Or, if the Fed could hike rates by more than the customary quarter percentage point. A half-point hike once or twice this year would also get investors’ attention.

Both the half-point hikes and the between-meeting increases have been done before — when Paul Volcker was Fed chairman in the 1980s. But it’s been so long ago that most people on Wall Street wouldn’t even consider these moves a possibility.

But they are.

Here’s the funny thing about the interest rate discussion — it might be unnecessary.

The monthly economic data produced by Washington agencies fluctuates wildly when it is first announced. Only after months and years do people really know what the economy was doing way back when.

It is very true that interest rates have been too low for far too long. And in normal times, this would mean that inflation is likely just around the corner and the Fed has reason to be concerned.

But nothing has been normal for more than 10 years. And with the US government already owing about $21 trillion and with Federal tax cuts going to add to that, the Fed is hyper-sensitive to economic data as it’s released. It can’t wait for the numbers to be perfected.

Even with Friday’s report that there were 313,000 jobs created in February, the nation’s economy seems to be growing at an annual rate of about 2.5 percent in the first quarter of 2018.

That’s barely better than during President Obama’s years. And it hardly warrants concern about overheating.

The February jobs report and the economy in general are major victories for President Trump, coming as they do in a string of good news — calming relations with North Korea (like it or not); tax reform; and a stock market bubble that hasn’t fully deflated yet.

The Fed could be the pooper at the president’s party.

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