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Time for the Fed to test the rate-hike waters?

After some careful consideration of recent economic data, I believe I have changed my mind about the near-term direction of Federal Reserve policy.

In many ways, it's not so much that I have changed my mind, but that the market may be changing my mind for me.

For the first time in several years, a variety of indicators are suggesting that current and future economic conditions may warrant normalization of the Fed's Zero Interest Rate Policy, known in wonk circles as "ZIRP":

  • The bond market is making a persistent push toward higher interest rates
  • Inflation expectations are rising, as evidenced by the rising "break-evens" in Treasury Inflation Protected Securities
  • Oil prices are rebounding
  • The employment-cost index is steadily rising

All of these add up to a changing environment. It could be time for the Fed to test the waters with a very small rate hike.

Dipping toes in water
Tim Denison | Getty Images

Ed Yardeni, one of Wall Street's most respected economists, recently noted that both the unemployment rate and the employment-cost index are both at the same levels as when the Fed started raising interest rates over a decade ago.

While the environment since has changed radically, interest rates around the world have moved violently off their lows, suggesting that, at least for now, the threat of deflation may be receding more quickly than some (myself included) may have thought.

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Indeed, the pace of economic growth, while still uncertain, is beginning to quicken in Europe and in other parts of the world thought to be permanently moribund.

Unconventional monetary policies are now the rule, rather than the exception, around the world whether in Europe, Japan, or now, China.

The world is more awash in liquidity today than at any other time in history. It's one thing to have the U.S. Federal Reserve holding the world up on its shoulders, it's entirely another thing for every major central bank in the world to act as Atlas simultaneously. It may be time for the American Atlas to shrug.

There could be some benefits to a move by the Fed this fall. I don't believe the Fed needs to move any sooner than that, despite my long-held expectations that the Fed would not move at all this year.

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First, the Fed could gauge the market's response, both domestic and global, to a move toward normalization. The initial rate hike, which could always be taken back, would also reveal to the Fed, and other policy makers, if there are true pockets of over-leverage, potentially dangerous bubbles, or any early warnings of systemic financial risk.

Just like the old civil-defense warnings we received on radio and TV during the Cold War, this would be a test, and only a test. If the Fed were to embark on a true emergency course of rate hikes, we would be immediately notified where to tune for further information!

Finally, and most importantly, the Fed would also get a good idea if the U.S. economy is, indeed, ready to stand on its own two feet. The data, while soft in the first quarter, have improved.

Auto sales are hovering at near-record levels, employment is close to the Fed's goal of full deployment, at least by its most narrow measure. But even the broad U-6 measure of unemployment is back toward levels consistent with economic recovery.

If the economy and markets falter, the Fed would have to indicate that the test run failed and that more time is needed for a complete recovery to take place.

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But with an election looming, this would also be a good time for the Fed to demonstrate its commitment to independence, irrespective of the presidential cycle.

The "message of the markets" is suggesting that there may be a secular turn in the deflationary trend that has been with us for years.

While I continue to fret about a 1937-style policy mistake that lifts rates too early in the cycle of recovery from a very deep recession, I am willing to concede that market-based indicators are suggesting that the time may be near for the Fed to attempt a turn.

In the immortal words of legendary econmomist, John Maynard Keynes, "When the facts change, I change my mind."

Commentary by Ron Insana, a CNBC and MSNBC contributor and the author of four books on Wall Street. He also editor of "Insana's Market Intellgence," available at Marketfy.com. Follow him on Twitter @rinsana.