It's a tough call. Really tough.
When Federal Reserve officials sit down next week, they will weigh volatile markets and a host of uncertainties about international growth against a U.S. expansion that is looking better with each new piece of data.
Futures traders are betting that the central bankers won't raise interest rates in a time of jumpy capital markets. Contracts on the overnight lending rate show less than a 30 percent probability of an increase this month.
Either decision — to raise, or not — has its own set of risks. Here are some scenarios raised in our reporting that investors are thinking about.
1. Don't raise now, and the "Yellen Put" is born
Investors now bet that Chair Janet Yellen and the Federal Open Market Committee will flinch at any sign of volatility in the future and start to push back even further their expectations of a rate increase. To preserve credibility, a central bank must do what it says it will do. The majority of U.S. central bankers have forecast for three years that they intend to raise the benchmark interest rate in 2015, according to their Summary of Economic Projections.
They have also said they are "data dependent," and so far the data look strong. Job openings surged to a record in July, auto sales through August are on their fastest pace in at least a decade and the jobless rate of 5.1 percent is within FOMC participants' estimate for full employment.
No hike would "kind of muddy the message in terms of data dependence," said Michael Feroli, chief U.S. economist for JPMorgan Securities LLC in New York and a former Fed Board economist. "They have shifted the message and now say data dependence includes financial markets."
2. Don't raise now, and the plan for gradual rate increases falls apart
Unemployment could fall further, leading to a definitive turn higher in labor compensation costs. Some segments of credit markets continue to heat up, and the Fed starts to look like it has waited too long.
The jobless rate could touch a low of 4.8 percent by year-end, said Neil Dutta, head of U.S. economics at Renaissance Macro Research LLC in New York. Nobody knows where the inflection point is on labor compensation, however the lower the unemployment rate gets, the more likely that wage inflation appears.
Meanwhile commercial real estate loans grew 12.5 percent at a seasonally adjusted annualized rate in July from the previous month following a 9.6 percent rate in June. The market for high-yield, high-risk loans in the U.S. is starting to spring to life after the weakest August for issuance since 2011.
The longer the Fed waits, the more they jeopardize the ability to raise interest rates slowly, Dutta says.
"The optics are going to be very interesting," he adds. "What are they going to say? The data are better but we aren't going to go?"
3. Raise now, and the fragile world economy will buckle
Global growth is already slowing as decelerating demand from China undercuts economies from Malaysia to Brazil.
International Monetary Fund Managing Director Christine Lagarde, who has advised the Fed to delay a rate rise until next year, said Sept. 1 that the global outlook is worse than the lender anticipated less than two months ago.
Ray Dalio, the billionaire founder of asset manager Bridgewater Associates, sees a rising threat of "deflationary contractions" worldwide and predicts the Fed will have to flood the economy with more cash next year to protect the U.S. from the blowback. Companies that sell debt in dollars rely on export earnings, or they have to convert their local currency into foreign exchange. A Fed rate increase could result in further depreciation of emerging market currencies against the greenback, making their dollar-denominated debt more expensive.
4. Raise now, and the Fed's credibility on inflation takes a blow
As measured by the personal consumption expenditures price index, the Fed's favorite, inflation has been below the central bank's 2 percent goal for 39 months. In July, the gauge rose just 0.3 percent from a year earlier.
Fed policy makers forecast in June that it will climb toward their target by the end of next year as the depressing effects of a stronger dollar and lower oil prices dissipate. Fed staff isn't so sure. Minutes from the July meeting showed that the "staff continued to project that inflation would be below the committee’s longer-run objective of 2 percent over 2016 and 2017." Inflation was anticipated "to move up gradually to 2 percent" after that.
"If they move in September, it would tell us that they are not weighting the global developments very strongly, they are not weighting the inflation disappointments very strongly," Julia Coronado, chief economist at Graham Capital Management, told a panel discussion at the Brookings Institution in Washington on Sept. 3.