Goldman: It&#39;ll Be A Disaster If Bernanke Raises Rates

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Not only does Goldman say the fed won't raise rates, but they even say that the Fed shouldn't; which if Goldman-conspiracy theorists are right essentially means the Fed won't.

Even for the rest of us, Goldman is basically setting themselves up so that if Bernanke raises rates before they forecast him to, it will be his error, not theirs, since they say U.S. isn't ready for it yet.

While some economic data makes it look like it's time to tighten, they argue that in reality it isn't time yet:

Goldman: Data Argue Against Changes in the Statement

On the surface, the backdrop for the Federal Open Market Committee meeting next week looks quite encouraging for members pressing the case for a gradual “exit” from the current accommodative stance. Real GDP growth probably accelerated to nearly 6% (annualized) in the fourth quarter; despite December’s worse-than-expected payroll employment report, job losses have slowed sharply over the past year; the jobless rate has been essentially unchanged for the last three months; and the stock market is up more than 60% from the lows of March 2009.

Inflation is low and the economy hasn't rebounded enough:

But in our view, serious consideration of a true “exit”—i.e., not just an end to the Fed’s liquidity support and asset purchases but an actual tightening of monetary policy—is still highly premature. Not only is inflation already modestly below the Fed’s 1½%-2% target, but the level of activity is so far below its potential that strong growth for an extended period is needed before tightening becomes appropriate. Put differently, the argument for continued accommodation would still be strong even if the economy was on track for solid above-trend growth in 2010, as some economists (and the Fed staff) believe.

Banks aren't arbitraging ultra-low discount rates:

For one thing, the benefit of a hike is highly uncertain. It is difficult to believe that much arbitrage is currently going on given how sharply discount window borrowings have fallen in recent months. As shown in Exhibit 2, primary credit at the discount window was just $15bn on Wednesday, well below the $111bn peak seen in October 2008. Moreover, most banks are currently able to obtain financing at rates well below 0.5% in the interbank market.

We don't need to drain liquidity yet:

We also are not sure that Fed officials will need to raise the discount rate in order to facilitate draining excess reserves. It is unclear whether—and if so when—they will actually decide to undertake such a drainage operation. Our own view is that the volume of excess reserves does not have important effects on the broad financial system and the economy, at least now that the payment of interest on reserves enables the FOMC to raise short-term interest rates without having to match the demand and supply of reserves. Moreover, even if Fed officials do introduce a term deposit facility that is priced attractively enough to mop up a significant share of the current $1 trillion excess, the rate on this facility would likely be well below 0.5% given the current slope of the yield curve. This would make arbitrage unattractive even without a higher discount rate.

The argument that a higher discount rate would be a signal that liquidity conditions have normalized is therefore similar to the phasing out of the other emergency facilities. But against this, it is important to consider the potential tightening in financial conditions if markets view such a step as a precursor to a hike in the funds rate. Especially at a time when the economy clearly needs all the monetary stimulus it can get, this risk should not be overlooked.

(Via Goldman Sachs, U.S. Economics Analyst, 22 January 2010)

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