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Why the Fed couldn't raise rates

There were a lot of reasons for the Federal Reserve to forego a first rate hike.

The labor market, despite a huge decline in the unemployment rate, is still displaying some troublesome signs. The labor-participation rate is hovering at levels last seen in the late 1970's, and the "underemployment rate" (U-6) has only just recently dropped to the peak levels seen following the 2001 recession. These metrics suggest much more labor-market slack than the headline unemployment rate would reveal.

Janet Yellen
Jonathan Ernst | Reuters
Janet Yellen

At the same time, the quality of the jobs being added is not what it used to be. Part-time jobs have replaced full-time gigs, and low-paying service jobs have replaced more lucrative manufacturing jobs. And the U.S. Census Bureau recently said that the median household income in 2014 was about the same level as 1996 after adjusting for inflation. These aren't the kind of metrics one usually associates with a thriving labor market.

And then there is the issue of inflation. Despite telling us that recent disinflationary pressures, caused in part by a stronger dollar and plummeting commodity prices, will be transitory, the Fed appears increasingly concerned that further economic deceleration in China (and elsewhere) could lead to more sustained pressure on price levels.

Were the Fed to hike rates prematurely, the dollar would likely resume its appreciation, commodity prices would continue to fall, and our trade deficit might spike higher, depressing both domestic GDP and inflation rates at a time when the Fed is trying to increase both. If the Fed really had confidence that the inflation will soon revert back to its target 2 percent, it didn't display that confidence in its latest statement.

And then there are issues relating to the stability of the global economy and global financial system. Leading up to the most recent meeting, the Fed had been strongly encouraged to defer the rate hike by emerging-market countries, the International Monetary Fund, and the World Bank. As expectations had risen that the Fed would soon hike rates, the dollar appreciated dramatically. This resulted in capital flight from emerging-market countries, which led to higher borrowing costs and inflation in those countries.

The fear was that a too-hawkish Fed could put emerging economies at further risk, and this could ultimately depress global economic growth. But perhaps more ominously, the billions in dollar-denominated debt that had been issued by entities in emerging countries would become much more difficult to service or refinance in the event of further capital flight. We suspect that the Fed's fears about conditions outside the U.S., including the increasing competitive currency devaluations, played a role in the decision to hold off today.

But none of those factors, however valid and impactful they may be, held the power to push Fed Chair Janet Yellen over the line to raise rates. The one factor that held that power was the recent volatility (read: "selloff") in the stock prices. Simply put, the Fed still places far too much importance on the stock market as a tool for priming the economic pump.

The 10-percent selloff in U.S. stocks, and the much greater selloffs in China and other emerging markets, was THE factor that provided cover for the Fed's decision today. To me, though, the capital-markets volatility we have seen in recent months represents the downside to an ill-conceived policy of targeting stock prices as a way to spur economic growth. The Fed's explicit strategy all along has been to boost household wealth through stock and housing gains, hopefully causing a trickle-down effect. Now, heavily committed to that strategy, the Fed believes that if it moves to soon to tighten, it will risk reversing some of those (perceived) hard-fought asset-price gains.

So, in exchange for very little economic benefit, the Fed continues to perpetuate the notion that it will protect those willing to assume undue risk. This strategy has helped create massive amounts of wealth (household net worth is up $30 trillion since the trough about six years ago), but at what cost? A small percentage of well-off Americans continue to enjoy the lion's share of income, wealth and spending gains since the Great Recession.

Meanwhile, evidence abounds that the middle class continues to struggle. Perhaps the most recent evidence of these struggles may be the presidential election-polling data. On the Democratic side, an avowed socialist (Bernie Sanders) is very near the top in many recent polls. On the Republican side, Donald Trump is leading the pack on a platform largely based on radical ideas to restrict immigration, expel illegals, and maintain more protectionist trade policies. Are these the types of candidates that would be supported by a thriving middle class?

The evidence is overwhelming that the economy is only working for a relative few, and years of ultra-loose monetary policy has done little to fix the situation. So why does the Fed keep doubling down on the same failed policies?

Commentary by Michael K. Farr, president of Farr, Miller & Washington and a CNBC contributor. Follow him on Twitter @Michael_K_Farr.