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Fed: three rate strikes and three more to come

Federal Reserve chair Janet Yellen oversees third interest rate rise of year and signals more to come to avoid US economy over-heating.

 
Fed: three rate strikes and three more to come

The US Federal Reserve has followed through with a widely anticipated interest rate raise for the third time this year and signalled it was on track to do the same in 2018 as it lifted its forecast for economic growth to 2.5% next year.

Reiterating their confidence in the strengthening US economy and rising employment, rate setters on the Federal Open Market Committee last night voted 7-2 for nudging the short-term funds target rate by another quarter percentage point to a range between 1.25% to 1.5%.

Although there was little reaction in currency and stock markets to the move, the central bank caused some unease by saying it would speed up the rate it withdraws the $3 trillion of liquidity it has pumped into the US economy since the 2008 financial crisis under its policy of quantitative easing (QE).

From January, the Fed will look to unload $12 billion of government bonds, or treasuries, and $8 billion of mortgage-backed securities that it has bought to pump-prime the financial system and buoy the US stock market for the past nine years.

Christopher Molumphy, chief investment officer of Franklin Templeton’s Fixed Income Group, said the Fed’s efforts to reduce its balance sheet as it hiked the cost of borrowing deserved attention given the elevated level of US bond and equity markets. ‘It is the first time anything of this scale has been attempted, so care must be taken by policymakers not to unintentionally trigger an adverse reaction.’

Outgoing Fed chair Janet Yellen said the timing was right. ‘Our decision reflects our assessment that a gradual removal of monetary policy accommodation will sustain a strong labour market while fostering a return of inflation to 2%, consistent with the maximum employment and price stability objectives assigned to us by law,’ she said in her final scheduled press conference before she is replaced by president Donald Trump’s nominee Jerome Powell in February.

‘Allowing the labour market to overheat would raise the risk that monetary policy would need to tighten abruptly at a later stage, jeopardising the economic expansion,’ Yellen explained.

Luke Bartholomew, investment strategist at Aberdeen Standard Investments, said: ‘Janet Yellen can leave the frontline of central banking with her head held high. Her tenure has corresponded with a big drop in unemployment, solid growth and the start of the great unwinding of QE.’

Nancy Curtin, chief investment officer at Close Brothers Asset Management, welcomed Yellen’s final pull on the interest rate lever. ‘The move is a clear sign that the US economy is back on track to a full recovery. We are near full employment, domestic growth has been strong and the economy is benefiting from a synchronised global recovery.’

While Trump’s plans to cut taxes are controversial, Curtin believed they could be positive if the political hurdles could be overcome. ‘Productivity is the next key challenge – as it is globally. If tax reform will help accelerate capital expenditure, we could see the holy grail of improving productivity and wage growth in the future.’

Tom Stevenson, investment director for personal investing at Fidelity International, predicted: ‘If 2018 plays out like 2017, with three rate hikes from the Fed, this could spell bad news for bond prices.’ Bond yields, which move in the opposite direction of their price, had already risen on the assumption that rates would be hiked. If rates and yields continued to push higher, the 30-year bond bull market would finally come to an end, he said.

However, this would not necessarily damage all areas of the US stock market. ‘Rising rates could be a good thing for certain sectors of the equity market such as domestically-focused companies in the US. Cyclical sectors of the economy, such as financial stocks, stand to do well as they profit from wider lending spreads when interest rates rise,’ said Stevenson.

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