US Fed moves closer to raising interest rates

Posted on November 23, 2016

The US Federal Reserve is moving closer to raising interest rates, as more officials say the central bank should act “relatively soon” and some push for a rise in December. 

The minutes from the November meeting — when the central bank kept rates on hold — released on Wednesday showed that officials increasingly thought that the Fed should raise rates soon. The view mirrored the statement by Janet Yellen, Federal Reserve chair, to Congress last week.

“Most participants expressed a view that it could well become appropriate to raise the target range for the federal funds rate relatively soon, so long as incoming data provided some further evidence of continued progress toward the Committee’s objectives (of maximum employment and 2 per cent inflation)”, the Fed said. 

That contrasted with the September meeting when only “some” officials wanted a rise to come relatively soon. The November minutes also revealed that some officials wanted the Fed to act in December to “preserve credibility” given public statements suggesting that the economy was approaching an appropriate condition for an interest rate rise.

“The Fed has their sights set on a December hike and these minutes just confirm that,” said Luke Bartholomew, a fixed income investment manager at Aberdeen Asset Management. “These minutes relate to a meeting that took place before the election. But the dust has settled from the election now and there’s not been the kind of negative market reaction that would warrant the Fed waiting any longer.”

In announcing on November 2 that it was keeping rates on hold — leaving the target range for its benchmark rate at 0.25 per cent to 0.5 per cent — officials had signalled the prospect of a rise when they meet on December 13-14. According to the minutes, they concluded that while the case for a rate rise had strengthened, they should wait for more evidence of inflation and a stronger jobs market before making a further move.

The Fed said participants — a broader group than voting members — indicated that their economic forecasts “had changed little” since September and that a “substantial majority viewed the near-term risks to the economic outlook as roughly balanced”. But it said some were worried about downside risks, including the risk of weaker than expected growth overseas and the “continued uncertainty associated” with Brexit.

The Fed said that the rate-setting committee “expected that economic conditions would evolve in a manner that would warrant only gradual increases in the federal funds rate and that the federal funds rate was likely to remain, for some time, below levels that are expected to prevail in the longer run”. 

US stocks were little changed on Wednesday, while the dollar modestly extended its gains against the euro on the minutes.

The Fed has held rates steady for seven consecutive meetings amid contradictory signs about the state of the economy, and amid political uncertainty that surrounded one of the most unorthodox US presidential elections in modern history. But policymakers have become increasingly vocal in calling for the first rise since December 2015 out of concern that the Fed risks allowing the economy to overheat, which would later force the central bank to tighten more aggressively. 

Stanley Fischer, vice-chair of the Fed, last week said the case for tightening policy was “quite strong” while stressing that the next move was not predetermined. “The Fed appears reasonably close to achieving both the inflation and employment components of its mandate,” he said. “Accordingly, the case for removing accommodation gradually is quite strong, keeping in mind that the future is uncertain and that monetary policy is not on a preset course.” 

The minutes from the September meeting had revealed that the decision to hold rates at that time had been a “close call” with three members of the Federal Open Market Committee dissenting over the decision not to increase rates. But the decision to hold rates stable in November was opposed by only two of the voting members. 

Recent economic data have pointed to an improving economy, including gross domestic product expanding at an annualised rate of 2.9 per cent in the third quarter. The jobs situation has also shown improvement with employment growth averaging 178,000 this year. 

Ahead of the election some analysts forecast that a victory by Donald Trump might spark a sell-off in financial markets that would inject more uncertainty into the calculations about when to raise rates.

But since his unexpected win, stock markets have instead focused on Mr Trump’s plans to ramp up spending, cut taxes and roll back regulation, and have powered higher as a result. All four of the biggest US equity indices hit new records this week for the first time since 1999. 

Meanwhile, bond markets have been hammered by fears that the president-elect’s policies will stimulate an economy running at or near full capacity, fuelling inflation and forcing the Fed to raise interest rates more aggressively than anticipated.

As a result, the 10-year Treasury yield jumped from about 1.8 per cent ahead of the election to over 2.4 per cent on Wednesday, the highest since June 2015. The DXY dollar index — which measures the currency’s strength against its biggest counterparts — has shot up to a 13-year high.

Twitter: @dimi

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