The unemployment rate is now a misleading number. Yes, the rate has fallen dramatically from its peak. But much of that decline has been the result of the fall in the labor force participation rate. It has fallen from a peak of over 67 percent in 2000 to 62.8 percent in August. So there is a long‐term trend downwards, which accelerated in the Great Recession.
If the unemployment rate falls because discouraged workers are leaving the labor force, that is nothing to cheer. And it is certainly no basis for a Fed rate hike.
Why the bullish sentiments of some Fed officials for a rate hike? I increasingly believe that there are unstated reasons buttressing their hawkish stance. They are likely concerns over financial stability issues. These officials certainly understand that a long period of low interest rates must result in financial bubbles. Capital has been mispriced and, hence, misallocated.
Additionally, margins have been squeezed for banks and other lenders. Finally, money market mutual funds have no sustainable business model at very low rates. These funds must pay to attract money, but can earn very little on their investments.
Negative interest rates would make these problems even worse, which surely explains the aversion of Fed officials to negative rates. The Fed has learned from the experience of countries that have taken rates into negative territory.
If Fed officials see a need to raise interest rates for financial stability reasons, they should make that case. Anemic economic growth and weak job growth just do not sustain the case for higher rates. For these and other reasons, I see no rate hike in September.
Notwithstanding the weak case for a September rate hike, Yellen has put the credibility of the FOMC on the line with her talk of a rate hike. I can still see the Fed hiking rates at the December meeting as it did in 2015. I cannot foresee two hikes in 2016. If there is an increase in rates in December, the Fed will pause again.