Fed’s Williams wants low rates, hot economy in 2016

On Wednesday night, the US Central Bank (the Federal Reserve) opted to raise its key benchmark interest rate from an historic low, the first such move since the onset of the financial crisis of 2007/8.

“Equities are all down and bond yields are down – partly because of stocks, partly because of lower oil, so the move is global”, said Ciaran O’Hagan, a strategist at Societe Generale. If that happens, he said, the Fed would not hesitate to cut rates and perhaps buy more bonds or promise to keep rates low for a certain period of time.

“There can be negative spillovers through capital flows, but remember, there are also positive spillovers from a strong USA economy”, Yellen said shortly after announcing the Fed’s first rate increase in over nine years.

Generally, though, the more the Fed necessarily involved itself in the direct management of a badly functioning economy, the more it became a political target.

Kishore Narne, associate director head – commodity & currency, Motilal Oswal Commodities, said, “We believe rather than Fed, the rupee is most impacted by the other emerging market currencies and yuan particularly for the directional cues”.

“The goal of the rate increase is to move away from emergency accommodation that was put in place during the depths of the Great Recession”, says Thomas Cassidy, senior vice president at Philadelphia-area Univest Wealth.

As the Fed’s rate increase kicks in and money-market funds start advertising higher yields, they’ll probably lure away hundreds of billions of dollars from deposits in banks, which the funds will lend to the Fed through reverse repos, Pozsar said. Higher rates mean they can charge more for lending. Yesterday’s hike is at the front-end of a plan to gradually raise rates over the next three years. But from the end of 2008 until this week, the Fed kept interest rates near zero, even though its low rate policy and other stimulus measures did not benefit the banks directly.

The Federal Reserve has made a decision to raise its rates in a watershed moment for the global economy. In addition to the rate drama of the past several months, Yellen has been fighting a rear-guard action all year against the Republican-led Congress, which wants to limit Fed regulatory powers.

To edge the target rate from its current near-zero level to between 0.25 per cent and 0.5 per cent, the Fed said it would set the interest it pays banks on excess reserves at 0.5 per cent, and would offer up to $2 trillion in reverse repurchase agreements, an aggressive figure that shows its resolve to pull rates higher. Fresh forecasts from the Fed suggest policymakers are looking for about four rate hikes next year. If the economy slows, it can lower rates again.

“The hints of further rate hikes moved the dollar because the market had priced in 2-3 more rate hikes in 2016″, Citi strategist David Wilson said. Jeremy Stein, a former Fed governor who has returned to teaching at Harvard, has observed that higher rates have the virtue of addressing even unknown problems. “We are still in a situation where most of our tools are fully employed”. The problem is that, to work, interest rate increases have to be slightly ahead of the economic curve, and the risk for equity markets will be if growth rates subsequently disappoint, or inflation does not pick up as expected.