The Fed: Betting on a rate hike

There is a growing sense that the worst of the credit crunch may be behind us. And despite a tamer-than-expected reading for April, inflation is still very much a concern for many Americans.

So with that in mind, could the Federal Reserve be forced to raise interest rates before the end of the year....even in the midst of the presidential race?

The Fed has historically been reluctant to make significant policy moves in the months leading up to the election.
TalkBack: Should the Fed raise interest rates before the election?

In fact, some Republicans still think that President George H.W. Bush would have won in 1992 if Alan Greenspan had lowered interest rates more aggressively.

Still, the market now seems to think that Fed chair Ben Bernanke may take action just a few days before Election Day on Nov. 4.

According to futures listed on the Chicago Board of Trade, investors are currently pricing in a 56% chance that the Fed will raise its benchmark federal funds rate by a quarter of a point, to 2.25%, at the conclusion of a two-day meeting on Oct. 29. Traders widely expect the Fed to keep rates at 2% at meetings in June, August and September.

There have been calls for the Fed to, at the very least, leave rates alone for the foreseeable future. Critics of the Fed have maintained that a relatively low federal funds rate, an overnight bank lending rate that affects how much interest many consumers and businesses pay on loans, has weakened the dollar and helped fuel the boom in commodity prices.

The economy, as it was in 1992, is likely to be the primary focus for this election. There is a reason why we at CNN and CNNMoney.com have dubbed this 'Issue #1' after all.

Even those who don't think the Fed would mess with an election think rates are heading higher by year's end.

"I really doubt the Fed would go and raise rates right before the election, especially one that's hotly contested. But I think they could definitely raise rates in December," said John Derrick, director of research with U.S. Global Investors Inc., an institutional investment firm based in San Antonio.

Still, if the Fed were to make a move just before the election, would that be the right decision? I'd argue yes. The Fed has to do its best to steer clear of politics. And even though raising (or lowering) interest rates in the days before Americans hit the polls might have an impact on the race, the Fed has to do what it is best for the economy.

If food and gas prices continue to rise and the dollar remains weak, the central bank may have no choice but to start raising rates.

At this point, it's unclear which candidate a rate hike would benefit (or hurt).

If it boosts the dollar and lowers oil and gas prices, a rate hike could actually make Americans feel better about the current economy.

What's more, many voters, particularly older ones, would welcome rate increases since that would lead to higher rates on savings accounts. The Fed's series of rate cuts since last September has caused rates on CDs, money market accounts and other savings instruments to fall below the inflation rate, a blow to many retirees.

So if (and these are admittedly big ifs) the housing market starts to show signs of stabilization later this year and the economy bounces back a bit as consumers spend their tax rebate checks, then inflation, not a recession, is likely to be the top concern for voters and the Fed this fall.

"There is no reason to think the Fed will do anything but sit tight for awhile," said Jim Glassman, senior economist with JPMorgan Chase. "But over the summer months, my guess is Wall Street will realize maybe that economic stimulus is working and those who thought the economy was falling apart may start pricing in more of a chance of tightening later this year."

And that means that the candidate that makes the best pitch for a stronger dollar and shows the best inflation fighting credentials could wind up winning the White House.

So instead of blaming Ben Bernanke for costing them the election, John McCain, Barack Obama or Hillary Clinton may actually need to thank him if the Fed raises rates in October.

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