Will Fed Raise Rates in Run-Up to Election?

A major economic policy move could come in the final weeks of the U.S. presidential elections. Traders are betting that before November, the Federal Reserve may execute an interest rate hike for the first time in two years.

It’s far from certain the Fed will hike rates this fall, despite the financial markets’ projections of a 25-basis-point hike by the end of October. Several Fed watchers don’t see the Fed hiking rates this year at all.

Some Fed analysts think it would be too tricky for the Fed to hike rates so close to the elections. For example, if the Fed were to raise rates at its Oct. 28-29 meeting, that would be only six days before the election.

A rate hike at the next Federal Open Market Committee meeting on Aug. 5 would be only three weeks before the Democratic National Convention. Fed spokeswoman Michelle Smith said election-year politics won’t be a factor in the Fed’s decision-making.

At the same time, transcripts of FOMC meetings show that Fed officials have considered and discussed elections at their policy meetings. In the Aug. 18, 1992, meeting, for instance, Fed Governor John LaWare expressed concern about a deterioration of the country’s economic psychology given that banks’ caution about lending and consumer fears about debt levels. At that same meeting, Fed Governor David Mullins mentioned the upcoming election as part of a list of “potential shocks and risks.”

While there has been a belief that the Fed doesn’t change interest rates just before an election, history shows otherwise. The central bank tightened during both the 2000 and 2004 election cycles, for instance. In 2000, it tightened as late in the political calendar as May. And in 2004, it tightened in June, August, and on Sept. 21, which was just weeks before the Nov. 2 election. Additionally, former Fed Chief Alan Greenspan famously hiked rates in 1988, the week before the Republican national convention.

The Fed won’t shy away from a hike if it’s necessary, said former Fed Governor Lyle Gramley, now an analyst at Stanford Group Co. “I don’t think the record suggests the Federal Reserve will not raise interest rates in the run-up to the elections,” Mussa echoed, even though he still doesn’t see the Fed making such a move this year.

However, in each of those election years, the Fed was just continuing a trend of rate hikes. “It’s another thing to start a tightening cycle a few days before an election,” said HSBC Securities Senior Economist Ian Morris, who also doesn’t foresee rate hikes this year. “It’s unwanted attention at a time when everyone will be focusing on the election. Do they really want to do that on Oct. 29?”

That said, the market’s expectations aren’t far-fetched. Fed officials have already put a greater focus on inflation threats. And while the Fed held rates steady at 2.00% at its meeting this week, Federal Reserve Bank of Dallas President Richard Fisher dissented, preferring a hike.

“We know from past experience they have (raised rates) when they thought that was necessary,” said Gramley. “It can be done.”

While the Fed raised rates in the months leading up to the 2004 election, “that was hardly controversial,” said MFR Inc. Chief Economist Joshua Shapiro, noting that unemployment rates were improving.

In contrast, the latest jobs data this year show payrolls falling 49,000 in May, all while the U.S. unemployment rate posted its sharpest one-month increase in 22 years. If you tighten monetary policy while people are struggling to find work, Shapiro said, “there’s going to be a political response.” –Maya Jackson Randall