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US raises interest rates, but what happens next?

The US Federal Reserve has raised its funds rate to 1.25%. The market is unconvinced further rises will come soon, opening the door to a shock if they do.

 
US raises interest rates, but what happens next?
 

The US Federal Reserve last night raised interest rates by a further 25 basis points, its second hike of the year, but given the slowing economic data, investors are split on whether a third increase will be seen this year.

By lifting its target policy rate to between 1-1.25%, Fed chair Janet Yellen (pictured) signalled her intent to try and normalise US monetary policy which will have huge implications for investors around the world.

She also laid down plans to reduce the central bank’s balance sheet in the second half of the year. It is bloated with the huge number of US government bonds, or treasuries, and mortgage-backed bonds it bought in the years after the 2008 financial crisis in order to lower long-term interest rates and pump prime the economy with cash.

However, despite the Fed’s apparent hawkishness, some commentators have questioned whether the latest flaccid employment numbers and overall economic indicators justify such a stance.

Consensus suggests that there will be a third rate hike this year, but Fidelity International global economist Anna Stupnytska is not so sure.

‘The tone of the statement came across as relatively hawkish, despite the disappointing readings on core inflation, which the Fed contributed partly to transitory factors,’ she said.

‘I still expect this to be the last hike for 2017, given emerging headwinds for the US economy, in particular for consumption, as well as the worryingly weak inflation and wage growth paths.’

Looking forward to the second half of the year, Stupnytska notes that a tighter labour market could put upward pressure on wages and prices, but argues there is considerable uncertainty around both the extent and timing of this.

‘In any case, any acceleration in wages and inflation is likely to be gradual, meaning the Fed will be under little pressure to tighten policy in the next few months,’ she said.

‘The second half of this year will be all about kicking off changes to the balance sheet reinvestment programme which in itself could have a small tightening effect for the overall economy.’

Not all observers agree though and plenty are sticking with the view that a further Fed rate hike is inevitable later this year.

Ian Kernohan, senior economist at Royal London Asset Management, said: ‘The Fed made little changes in the language or projections for further interest rate hikes. They acknowledged that inflation was running below target, but also that job gains have been solid. We expect another rate hike and some balance sheet normalisation before the end of the year.’

Not evveryone is taking the Fed seriously. Kathleen Brooks of City Index was concerned that market was forecasting a slower pace of US rate rises than the Fed indicated in its notorious ‘dot plot’ graph

She said the dot plot expects rates to rise to just over 2% by 2018 , however, the Fed funds futures and the OIS market pointed to a much milder trajectory with just one further hike in the next year.

‘Is the market always right? Not always, but this disparity is odd, and could play havoc with asset prices if the market has been wrong-footed and needs to play catch up with the Fed, which could see a sharp turnaround for the dollar and US [bond] yields,’ Brooks warned.

 

 

 

 

 

 

1 comment so far. Why not have your say?

Nick-

Jun 15, 2017 at 20:25

The Bank of England stick in the mud attitude may now change as our inflation is reported as 2.9% which is higher than in the USA. After all what ever US do we copy. On the other hand, perhaps they got use to rub the pensioners politics with spend and spend policy with active do not save approach.

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