Thursday 22 February 2018

Fed set to raise interest rates for first time since 2006 today, markets braced

Janet Yellen, chair of the US Federal Reserve
Janet Yellen, chair of the US Federal Reserve

Peter Spence

Global markets are braced for the most pivotal moment since the financial crisis, as the Federal Reserve prepares to raise interest rates for the first time in nearly a decade.

The US central bank is expected to increase interest rates from their current 0pc to 0.25pc range today.

Despite the change in policy being “priced in”, traders will nonetheless be on edge as Janet Yellen, the Fed’s chairman, outlines plans for future rate hikes.

Larry Summers, the former US Treasury secretary, warned that a move to raise rates would be premature. “There are still substantial questions about the growth prospect, about the prospect of achieving the 2pc inflation target, about uncertainties in financial markets,” he told Bloomberg.

Source: NBER, OB Global Markets
Source: NBER, OB Global Markets

Fed policymakers have been hesitant to tighten policy, preferring to wait for signs that inflation was on a path back to the central bank’s 2pc target.

The dollar climbed by more than 0.6pc against the pound on Tuesday, after inflation data seemed to secure the case for interest rates to rise.

Unfortunately it's probably not that dramatic as we think the Fed will struggle to get that far off lift off before the cycle eventually turns over

The latest figures showed that one measure of inflation rose by a greater than expected 0.5pc in the year to November.

So-called “core inflation”, which strips out more volatile components, climbed to an 18-month high of 2pc, from 1.9pc in the previous month.

While economic conditions might present a “Goldilocks moment” for the Fed to take its first steps towards higher rates, analysts warned that it may soon have to retrace its steps. Jim Reid, a strategist at Deutsche Bank, said that officials will probably not “get that far… before the cycle eventually turns over”.

“If the next recession comes in the next couple of years, it's hard to imagine rates being high enough that the Fed will be able to avoid returning to zero again with risks that a fourth round of quantitative easing will be needed,” Mr Reid said.

Bricklin Dwyer, a BNP Paribas economist, said there was a “high chance” that things would not go according to plan. “The risk that things go wrong is greater than things going well,” he said, as policymakers may find that the US economy is already slowing, and that a string of rate rises turn out to be too “aggressive”.

Anticipation of the shift by the Fed has prompted sharp adjustments in financial markets since the summer, as investors adjust after seven years of close to zero rates. An exit from very stimulatory policy signals the end of a lengthy period of financial repair in the US, as the wounds inflicted by the 2008 crash have taken an unprecedented length of time to heal.

The Fed has repeatedly found its attempts to raise rates thwarted by external factors; firstly by severe falls in commodity prices, which have weighed down on inflation; and latterly by concerns this summer that global growth had faltered in emerging markets.

The big drops in emerging market exchange rates already seen this year were partly in anticipation of a Fed action.

The interest rate rise is unlikely to be a “one and done” move, but the first in a series of increases that could cause turmoil in emerging markets.

Ms Yellen will be keen to repeat the Fed’s mantra that rises will be limited and “gradual”, stressing that subsequent rate hikes will come at a slower pace than in previous cycles.

Steven Hess, an analyst at ratings agency Moody’s, said there was a risk of a “disorderly reaction” if officials were unable to assure investors that it would tread carefully over the coming months.

“The large emerging markets that will likely be most affected are those, such as Brazil, Russia, Turkey and to some extent South Africa, where severe domestic challenges have contributed to exchange rate and financial market instability,” he said.

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