Fed: Still Credible

Last week, the Federal Reserve won its undeclared war against the market. For months, the market had been pricing in rate cuts, despite the fact that the Fed had given no indication whatsoever that any rate cuts were in the offing. No longer: the curve is steepening, the priced-in probability of a rate cut is down to zero, and the markets admit that worsening inflation is a bigger problem for the Fed than falling GDP growth.

All this is not enough, however, for Irwin Kellner, who thinks the Fed should and will raise rates in two weeks' time.

Judging by the number of signals that central bankers have sent in recent weeks, the Fed could very well decide to raise rates as early as this month. If they don't move in June, then they'll probably pull the trigger in August.
After all, there's a limit as to how much more inflation the Fed can afford to tolerate before the markets begin to question its credibility.

I can just about understand – although I don't necessarily buy – the June rate-hike call. Inflation is rising, the Fed has said that it's worried about inflationary pressures, and there's got to be some chance that the Fed will do what it has long said that it might do.

But I don't buy the credibility argument at all. Remember that up until last week, the market thought a rate cut would be more likely than a rate hike – and they thought that without impugning the Fed's credibility one iota. If the Fed fails to hike in June, that will be just fine by the market.

The way I see it, the market increasingly sees a rate hike as possible, but it's a long way from seeing a rate hike as necessary. The Fed is still ahead of the curve here, which means that its credibility, at least for the time being, is not at issue.