Three reasons the Fed wants to hike rates in March

Federal Reserve chair Janet L. Yellen said a March rate hike would be “appropriate” if the economy continues to evolve as expected, signaling that the central bank will likely raise its benchmark interest rate sooner than many economists and investors had expected just a few weeks ago.

Although some analysts have speculated that the accelerated timetable for the rate increases could lead to more of them overall, Yellen appeared to affirm the Fed's position of three quarter-point rate hikes this year.

“At meeting later this month, the Committee will evaluate whether employment and inflation are continuing to evolve in line with our expectations, in which case a further adjustment of the federal funds rate would likely be appropriate,” Yellen’s prepared remarks read.

With the job market strengthening and inflation rising toward our target, the median assessment of FOMC participants as of last December was that a cumulative 3/4 percentage point increase in the target range for the federal funds rate would likely be appropriate over the course of this year,” Yellen said, adding that the Fed is projecting “additional gradual rate hikes in 2018 and 2019.”

Elsewhere in the speech, she indicated that the economy was meeting the Fed's expectations. “The economy has essentially met the employment portion of our mandate and inflation is moving closer to our 2 percent objective,” she said.

Strategists and economists have come up with reasons they believe the Fed could feel compelled to get off the sidelines and begin delivering the three rate hikes it has forecast for this year.

The first reason is Financial Intelligence. Right about when the Fed would vote on a rate hike March 15, the legislated extension of the debt ceiling expires, putting Congress on notice it needs to come to a budget solution to avoid default. The government would run out of money sometime in the fall, and that's when the budget battling could really heat up in Washington. While it's widely expected the administration and Congress will work out a deal.

A second reason is something Fed critics and fans alike have been concerned about for a very long time. In a note, the Fed may be worried it is going to overshoot on full employment and fan inflation. That would mean the Fed is behind the curve, which is something that constantly nags at markets.

"Recently, Fed speakers have been rhetorically asking whether the FOMC is behind the curve. While they consistently answer in the negative, the very fact they are asking the question may belie the doubts in their own heads. Even the most jerry-rigged policy rules have a hard time justifying rates where they are.

A third reason, is that the Fed has a perfect runway to land a rate hike. What has changed is equity markets. Financial conditions have eased considerably over the last little while. The increase in the equity market hasn't been associated with an appreciation in the dollar.

Stocks did pull back Thursday, after rallying to record highs Wednesday on the best volume of the year. The Dow was down 112 at 21,002, but yet to be seen is whether it is responding to a more than 300 point run up or concern the days of easy money are ending a little bit sooner. The Dow is up about 14.5 percent since the election.

Bond yields have snapped higher in the last week, with the Fed-sensitive two-year Treasury yield dramatically higher at 1.32, the highest level since 2009. 

If the Fed does move as expected, and the economic data cooperates, the market will have a new dilemma when it raises rates in March.