Capitol Hill drama complicates Fed rate hike

Federal Reserve officials will gather in late September in an effort to determine if the time is right to raise interest rates for the first time in nearly a decade.
 
Washington policymakers, meanwhile, will likely be making matters much more complicated for the central bank.
 
Fed watchers will be glued to the meeting that wraps Sept. 17, with many believing the central bank could finally raise rates after years of basement-level borrowing rates.
 
While the central bank has indicated it wants to raise rates sometime in 2015, officials have to weigh a host of economic factors, both in the U.S. and across the globe, to decide when the economy is strong enough to weather steeper borrowing costs.
 
And the Fed will likely have to make that call with little knowledge about what Washington has in store for the economy at the end of 2015.
 
In the weeks following the Fed’s September meeting, lawmakers will be trying to avert a government shutdown, raise the debt limit before a catastrophic default and hope to pass longer-term legislation funding a host of highway projects. All those issues can weigh significantly on the economy and financial markets.
 
While congressional leaders insist they will find a way to get all of that done in the last few weeks of the 2015 legislative calendar, there is no clear path forward for any of it at this point.
 
That leaves the Fed to grapple with a host of other complex issues, such as China’s economic slowdown, a strengthening U.S. dollar and financial market drama, with little hint if policymakers plan on upending the economy before the year is out.
 
“It’s really a tough call,” said David Wessel, director of the Hutchins Center on Fiscal and Monetary Policy at the Brookings Institution. “It would be nice for them if fiscal policy was stable.”
 
Currently, Fed watchers say the potential for Washington drama is likely low on the Fed’s priority list, as global economic concerns and the state of the U.S. labor market and inflation loom larger. But if policymakers return from the August recess and spend the first half of September in an unproductive feud, it could help nudge the Fed toward pumping the brakes on a rate hike.
 
“I think the unresolved policy matters in Washington are low on the Fed’s list of concerns when judging when to begin raising rates,” said Mark Zandi, chief economist with Moody’s Analytics. “If those odds increase materially over the next few weeks, it may then impact the Fed’s thinking and they will wait until December or later to hike rates.”
 
Since the Fed will be meeting before lawmakers are expected to resolve any of the pressing issues on government spending, regulators will likely have to presume that Washington avoids a catastrophe and Congress gets its job done.
 
“They typically go with the assumption that these things will be resolved,” said Joe Gagnon, senior fellow at the Peterson Institute for International Economics. “You can’t plan monetary policy on the slight chance that Capitol Hill will blow up.”
 
But if Congress and the White House cannot come together on some of these issues, there will be an economic cost.
 
Standard & Poor’s estimated that the two-week government shutdown of 2013 cost the economy at least $24 billion. Consumer confidence also takes a hit when Washington breaks down. That can lead to a decline in consumer spending, which makes up a huge chunk of the nation’s economy.
 
Given that there are a host of other issues weighing on the economy at the moment, the chance of another economic hit and market turmoil — care of Congress — could weigh on the Fed’s thinking.
 
“Financial markets could be pretty jittery if, on top of China, and on top of oil prices falling, and on top of chaos in Greece and on top of who knows what’s next in the Middle East, we also have the uncertainty about whether Congress is going to have a shutdown,” said Wessel. “That would all contribute to an unwelcome tightening of financial conditions.”
 
China’s recent currency devaluation drew headlines and roiled markets.

Diane Swonk, chief economist with Mesirow Financial, argued that the turmoil in financial markets would “trump anything in D.C.” as far as the Fed goes.

Swonk said she had stuck with her September forecast until the precipitous fall in the markets this week. She now is of the view that the Fed will be “lucky enough” to lift off on a rate hike by December.
 
But Roberto Perli, chief economist at Cornerstone Macro, said China on its own could land well down on the list of factors the Fed will weigh.
 
Even with Washington facing major fiscal decisions next month, the bigger concern is the combination of currency drops that have upset global markets, continued appreciation of the U.S. dollar and plummeting oil prices — all of which will factor into an already difficult equation on the interest rate, Perli said.
 
If those issues flare up ahead of the Fed’s meeting next month, the inflation-watching Fed’s chances of raising rates falls to 20 percent from the 50-50 chance Perli predicted earlier this week.
 
He said deflation is a major concern and “negative domestic inflation would be a disaster.”