Conventional wisdom is that the Federal Reserve entered its two-day policy meeting on Wednesday as confused as ever about what to do with interest rates. Should the central bank raise short-term rates slightly to send a signal that the U.S. economy is strong enough to handle more “normal” rates?
Or should it leave rates near zero—where they’ve been since the depths of the global financial panic—because the U.S. economy is truly threatened by the global slowdown?
Well, investors are just as confused about what the Fed will do. Or should do. Professional investors are split evenly about what to expect tomorrow afternoon, when the Federal Open Market Committee will announce its decision on rates. A new CNBC survey found that 49% of forecasters surveyed believe the Fed will raise rates tomorrow.
The economic data offer little clarity, because the figures have been so mixed. The labor market continues to show signs of improvement, with the unemployment rate down to 5.1%. And the Commerce Department reported that the economy expanded an annual rate of 3.7% in the spring, hardly a harbinger of recession.
On the other hand, the Federal Reserve Bank of New York reported that its regional manufacturing index had shown contraction in September.
This came on the heels of a report that industrial production throughout the nation fell slightly in August compared with July. And a separate report showed that business inventories only rose a slight 0.1% in July, a tepid signal of confidence in growing demand.
Weirdly, these reports have made Wall Street a bit more bullish. On Tuesday, thanks in part to the New York Fed manufacturing report, the Dow Jones industrial average soared 229 points and the benchmark index was up more than 100 points on Wednesday afternoon.”Bad economic fundamentals used to be bad news for stock prices,” says Thomas Forester, chief investment officer for Forester Capital Management. “Now it means good news because it means the Fed may not move rates higher.”
This is also why Wall Street will be bracing for a sell-off tomorrow if the Fed goes ahead and moves rates higher.
Of course, there’s yet another school of thought that says if the Fed postpones raising rates, that would lead to more rockiness going forward. “If I were them, I would just go ahead and do it,” says Mary Ellen Stanek, chief investment officer for Baird Advisors. By holding off rate hikes this long—triggering a guessing game of ‘will they?’ or ‘won’t they?’—she argues, “the Fed has been creating drama and volatility that’s not helpful here.”
Who’s right? It’s anyone’s guess.
But all of this confusion means that no matter what the Fed decides tomorrow — the announcement is due a little after 2 pm ET — the market reaction is likely to be quite volatile.