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How the Fed’s rate hikes could put economy in the hole

The Federal Reserve raised its key interest rate on Wednesday, just as it has done seven other times since late 2015. It was just as everyone expected.

In doing so, the Fed repeated a lot of what it has said before about the economy — it’s growing stronger and the labor market is good. And the Fed also tipped its hand that borrowing costs will continue to rise with another hike likely coming in December — with more next year.

The big news was that it omitted the word “accommodative” with respect to its policy. That last thing is important to the mind readers on Wall Street who want to know how long these rate hikes will continue.

To anyone who has been following the Fed for any length of time, this week’s meeting — like all the others this year chaired by newcomer Jerome Powell — was a “Groundhog Day” event. Same old, same old.

And like a groundhog, Powell may be digging himself into a hole.

There are a lot of things that need to be considered every time the Fed raises rates. The first is that the Fed isn’t omnipotent. When it raised the Fed funds rate to between 2 percent and 2.25 percent, it was suggesting to the financial markets that borrowing costs should be higher. And big swings were seen, with the Dow Jones industrials jumping almost 70 points before tumbling in late trading, to close down 106 points.

The rate hike is only a suggestion — a powerful one, to be sure — but one that the open market can choose to ignore.

The other thing that needs to be noted is that the Fed is tightening interest rates when the economy is growing, but there’s no guarantee that it is growing as swiftly as people believe. There is at least one indicator that says growth is well below the 4 percent annual rate everyone is assuming. (More on that in a future column.)

And growth at around 4 percent — if that’s where it is — has been achieved before in recent years only to see the economy falter. What if the current pop in the economy is transient and is about to weaken even without Powell’s rate hikes?

The Fed’s hikes could send this growing economy back into the doldrums, especially since much of this year’s growth can be attributed to the tax cuts that went into effect early this year.

What if the positive effects those tax cuts might be having on the economy are temporary? What if consumers exhaust their desire to spend at the same time the economy is being slowed by Powell’s rate hikes?

Those tax cuts had another profound effect on America. They increased the federal deficit, even as tax revenues gained.

In other words, spending by the US government is increasing faster than the tax revenue gains.

And because Washington needs to borrow more money to pay for the increased deficit — which could soon reach $1 trillion a year — it will have to borrow at the higher rates toward which the Fed is moving the markets.

There are a lot of other holes the Fed could be digging.

One, what is the impact of higher rates on the economy at the time when a trade war with China, and possible other countries, is underway? In his comments after the rate hike announcement, Powell said the Fed isn’t responsible for trade, but he noted that there is a “rising chorus of concerns” among businesses.

And what if China takes this opportunity to lessen its $1.3 trillion portfolio of Washington’s securities, or even sell US government bonds? What if this causes interest rates to go even higher than the Fed wants?

What if the trade war slows the economy that is already being slowed by the Fed’s rate hikes, giving us a double whammy?

I don’t claim to have covered everything here. But let me wrap this up with a theory that I’ve been latching onto for years: The problem with the US economy isn’t just that it has been weak. The problem is that, because of our deficits, it’s also broken.

And by that I mean that things that are supposed to get the economy out of a funk — like tax cuts — are really just allowing other problems to surface, like the increasing US debt and the rising interest payments on that debt.

There is good news for some. Savers can today get a better rate on their money and interest payouts are likely to increase over the next few years — unless, the groundhog comes out its hole, is spooked by one of the problems I just mentioned and decides that rates need to go down, down, down again.

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