Federal Reserved expected to hike rates

The market is certainly pricing in a very high chance that the U.S. Federal Reserve will hike this week, but are investors prepared for the Fed’s rate to rise as high as one per cent next year? The inflation rate in the 12 months to October in the country is at 0.2%.

SIFMA’s Economic Advisory Roundtable anticipates an interest rate hike of 25 basis points this week, with survey respondents citing improving labor conditions, readings of financial developments and inflation or inflationary expectations.

Deutsche Bank noted that markets on average are expecting just two increases next year while in the FOMC’s September projections four increases to end at about 1.5 percent were indicated. That has removed some of the uncertainty that investors dislike.

Banks and other financial institutions are so awash in Fed money that the central bank has been forced to deploy new tools that economists say are likely to be less precise than previous methods and could roil jittery markets.

Share prices also tend to benefit from monetary stimulus – but the S&P 500 is already trading lower than at the start of the year, implying the impact of the rate rise might already be priced in for equities.

In the United Kingdom, a USA move could be seen as clearing the path for a hike by the Bank of England – which has left rates on hold at the historic low at 0.5% since 2009. “Holding the federal funds rate at its current level for too long could also encourage excessive risk-taking and thus undermine financial stability”.

But financial markets are forecasting, overwhelmingly, that the Fed will raise its policy rate this week.

Wage growth has been sluggish, with workers unable to earn their share of what was lost in the recession, and November’s jobs report showed that it slowed to a crawl for many workers.

Yet even core inflation, which strips out risky meals and power prices, has hovered under the central bank’s annual 2 % goal, it identified.

Instead, it has set the funds rate in recent years by paying banks 0.25% in interest to park their excess reserves at the Fed.

Worth pointing out is that although any rate hike this month will take immediate effect, it is expected to be so miniscule as to not make a big difference in anyone’s immediate budget.

“It can’t come out and say we are only making one hike and then will see how the economy responds, because if your economy can only stomach one hike it is in such a fragile state that you shouldn’t be hiking at all”, he said.

But with inflation and the employment market still well away from the Fed’s targets, some question whether it needs to act now, especially as much of the rest of the world is moving in the opposite direction, easing monetary policy, to counter weak economic growth.

What all the “dovish hike” discussion seems to really mean then is nothing new, but rather more of the Fed’s same old, wrapped in new packaging: it depends.

Nonfarm payroll gains of 211,000 may lead to the first interest rate increase in almost a decade. “Managing the message will be central to the Fed’s communication effort with the markets”.

“Given the strength of the signals that have been sent it would be credibility-destroying not to carry through with the rate increase”, economist and former US Treasury secretary Larry Summers wrote in a blog post Tuesday.