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Expectations Met:
FED Raises Short-Term Rates For First Time Since 2006
As expected by a large majority of economists, investors and analysts, the Federal Reserve Bank of the United States has decided to finally raise short-term interest rates. At today's meeting the long anticipated announcement was made that the central bank will raise rates to the "0.25-0.50% range."
Thus we come to the end of the days of the ZIRP--Zero Interest Rate Policy--which was implemented in the depths of the economic crisis of the late Bush Administration. Although it remains to be seen if this rate increases will be followed by anything resembling a return to normalcy and higher rates in the near future. The Fed noted that they “[expect] economic conditions will evolve in a manner that will warrant only gradual increases in the fed funds rate.”
While this increase was almost a foregone conclusion for many in recent weeks, it remains to be seen whether or not it was the right move given the-still-precarious state of the world economy. Recent moves in commodities prices--especially copper and oil--have indicated anything but an inflationary environment.
And while we have seen some wage increases within the US, they are hardly of the sort to provide the average US worker a decent pay raise after seven long years of stagnation. We still don't see a rip-roaring labor market as one would expect in a recovery in full bloom. Economists have been arguing that perhaps the old Fed standby unemployment figure for "full employment" of 5% may be outdated given the changing demographic nature of the US work force, the depth and breadth of the Bush economic crisis, and the long-standing stagnation in wages for many workers.
We keep in mind that the Fed has a two-pronged mandate: control inflation/integrity of the money supply AND ensure "full employment." We don't see inflation at any meaningful level. In fact, inflation has run below its preferred level (2%), for more than three years.
Indeed, it seems that in large measure this miniscule rate hike may have had more to do with not letting down expectations and "sending a message" vis-a-vis confidence in the overall US economy. Lack of an increase may have sent a signal that the Fed was nervous and may have caused a nasty Christmas surprise for the markets.
We don't see any huge jump in rates coming down the pike, as officials remain cautious about the underlying state of the US and world economies. That's a good thing, as some economic analysts and media personalities have displayed a rather shocking ignorance about the intended effects of rate hikes on the inflation rate. Recently some pundits have made statements such as "the Fed rate hike should increase inflation" when it will have the opposite effect according to any Econ 101 textbook. Rate hikes are designed to control inflation and keep it near the desired target figure. By itself a rate hike will NOT make inflation increase because it should make it more expensive to borrow money and thus it should tap the brake on economic growth.
For now, the average investor, worker, and consumer will most likely see little impact on their daily lives. The small increase should not trigger huge jumps in mortgage, credit card, or auto loan rates. And savers, long suffering under the ZIRP, are not going to see massive increases in CD rates anytime soon.
We also don't expect much a change in the market as managers do their usually tidying up of their year-end balance sheets and many go on holiday vacations. This increase was widely expected and widely telegraphed. So far, any pernicious effects are limited to the dollar and some emerging markets Forex rates as well as the junk bond market. The Fed's promise to continue to hold huge positions in mortgages and other instruments should keep the markets well shielded from any deep shocks from the modest rise in short-term rates.