The Fed: December Liftoff Now Likely
The Fed didn’t take action in September, leaving short-term interest rates near zero since December 2008. This was consistent with the majority of market participants’ expectations.
Fed officials have continued lowering their projections of the pace of raising interest rates in the past four projections. See the chart below:
The projection on GDP in 2015 was revised upward, and the unemployment rate projection went down, indicating the Fed improved its outlook for economic conditions. But PCE (personal consumption expenditures) inflation was projected largely lower than the previous projection.
Here’s what to expect next – and don’t panic when it happens.
December now has become the mostly likely case for the initial rate increase by ¼ percent or ½ percent. Either ¼ percent or ½ percent increase is a fairly small increase in the federal funds rate compared to its historical average level of 5 percent. The move is rather a signal to the market that a tightening monetary policy environment is coming.
It is more interesting to see if the Fed will pull it back in the near future as other central banks did after the initial rate increase takes place, or at what pace the Fed will continue to raise the interest rates.
A higher interest rate normally puts constraints on borrowing. But the first interest rate rise could be seen as a signal of even higher rates in the future. Hence, consumers and businesses may borrow sooner than later, boosting borrowing in the short term.
As lenders, due to higher interest rates, banks have a higher opportunity cost for having their excess reserves sit in the central bank. In other words, banks have more incentives to lend.
The stock market will immediately react to the Fed’s action on raising rates. But the dust may not take long to settle on the table. History shows stock market performance has little correlation with the broader economy using a longer perspective.