Home Central Banks Fed Hikes Interest Rates by 0.25 Percent

Fed Hikes Interest Rates by 0.25 Percent

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By: Alessandra Yuan – Forex Focus

Cites robust labour market and economic activity as key drivers

The US Federal Reserve (the Fed) voted unanimously to raise benchmark interest rates by 25 basis points to a range between 2.0 and 2.5 percentin September, following its two-day monetary-policymeeting. The rate hike was in line with market expectations; with this third interest-rate increase this year, the federal funds rate in the United States spiked to its highest point since April 2008, shortly after Lehman Brothers declared bankruptcy. This is the eighth increase in rates since the Fed began its tightening cycle in December 2015 and the seventh in the last eight quarters.

The federal funds rate serves as a benchmark for a host of consumer loans in addition to determining interest rates on savings and deposits. The increase in rates will immediately affect prime rates, credit-card charges and loans, while its effect will be incremental in some of the other areas. The benchmark overnight lending rate, meanwhile, rose to 3.4 percent, about half a percentage point above the Fed’s “neutral” rate, a level that neither supports nor restricts economic growth.

In its press statement, the Federal Open Market Committee (FOMC) said that the risks to the economic outlook are balanced and complimented the strong labour market, where unemployment levels have seen a solid decline and growth in household spending and business investment have been among the key drivers leading to robust economic activity in the country, also instrumental in pushing both nominal and core inflation to around the bank’s target of 2 percent.

The Fed maintained that the future timing and size of any federal funds rate increase will be in line with sustained expansion of economic activity, a strong labour market relative to its maximum employment objective, outlook on the financials, international developments and last, but not the least, inflation remaining close to the central bank’s medium-term objective of 2 percent.

Following are some of the key highlights of the Fed’s monetary-policymeeting in September:

  • Leaves its plan to steadily tighten interest rates intact.

  • Expects to increase interest rates one more time this year, thrice next year and once in 2020.

  • Forecasts the pace of US economic growth to steadily decline over the next three years.

  • Raises its expectation for full-year 2018 GDP (gross domestic product) growth rate to 3.1 percentfrom 2.8 percentin June, from 2.4 percentto 2.5 percentin 2019 and unchanged at 2.0 percentin 2020.

  • Expects the unemployment rate to rise to 3.7 percentfor full-year2018, up from its earlier estimate of 3.6 percent.

  • Forecasts PCE (personal consumption expenditure) inflation to remain unchanged at 2.1 percentthis year, with next year’s figures expected to moderate to 2.0 percentfrom June’s forecast of 2.1 percent.

While the Fed maintained that the risks to the economy were well balanced, it didn’t highlight the risks to the United States and the global economy arising from the impact of trade tariffs. The other notable feature of the Fed’s statement was the word accommodative, which has been a part of numerous monetary-policy statements over the years. The word was missing, indicating that the Fed will move more aggressively with its monetary-policy stance—although the Fed’s chairman, Jerome Powell, played down the alteration in the statement, saying that it does not signal a change in policy but only means that the policy is moving in line with the expectations of the central bank.

The Fed’s interest-rate hike on Wednesday, September 26, also drew sharp criticism from President Donald Trump once again. On the sidelines of the UN General Assembly, Trump told a press conference that he sees the Fed’s actions countering his efforts to boost the economy and leaves businesses with the choice of either paying down debt or creating more jobs.

Coming to the financial markets, the yield curve on US Treasuries flattened with the benchmark 10-year notes US10YT=RR at 3.0499 percentfrom 3.102 percenta day earlier. The U.S. Dollar Index (DXY) initially weakened against a basket of currencies following the interest-rate decision before ending the day’s session higher by 0.29 percent. The rising greenback also pushed the Canadian dollar to its lowest level in a week amid fears that Canada would find itself isolated from the NAFTA (North American Free Trade Agreement).

US equities, on the other hand, initially extended gains before settling in the red, with the Dow Jones Industrial Average (DJIA) closing at 26,385.28, lower by 106.93 points or 0.4 percent, the S&P 500 Index coming off by 0.33 percentto settle at 2,905.97, while the Nasdaq Composite slipped by 17.11 points or 0.21 percentto end Wednesday’s session at 7,990.37.

While most European stock indices closed in the green on Wednesday, a majority of Asian markets continued to extend losses ranging between 0.2 to 1.0 percenton Thursday.

 

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