The case is growing for the Fed to hike rates sooner and more aggressively than the market is expecting. As a result, investors should brace for what strategists at Scotia Capital feel is a needed change in tone from the Fed in the coming months, including dropping or softening its important “extended period” reference.
“That will ultimately result in increases to each of the interest on excess reserves, the Fed funds target rate, and naturally the effective Fed funds rate,” Derek Holt and Karen Cordes said in a research note. “The case for emergency rates has waned and we’ve transitioned toward the need for a different, low-but-not-emergency rate environment.”
They argue that this is ever truer in Canada.
One of many things to watch is excess capacity, which is still in massive supply, but is being closed off. This still requires low rates, just not emergency rates. After bottoming at 68.3% in June, it climbed to 72% in December.
The Scotia strategists, who note that the unemployment rate may be peaking now or soon, believe job growth will resume in the U.S. economy this year.
“Zero liquidity and frozen credit markets amplified the just-in-time inventory management cycle’s response to the deleveraging shock such that production and employment over-corrected in dropping over 7 million jobs in 2008 and 2009,” they said. “Automatic stabilizers require re-hiring some of them, and so does fiscal stimulus.”
They also feel that continued challenges in the housing market alone will not keep the Fed from hiking in the second half of 2010.
Finally, if the market corrects on anticipated hikes, the strategists suggested that the Fed might be in a better position to actually deliver hikes by clearing such concerns out of the way.