After talking about it for about two years, this week the Fed finally started a new rate hiking cycle after 7 years of interest rates at zero. The Fed raised the range for its policy rate from 0-0.25% to 0.25-0.50%. In 2016, further rate hikes will follow. The impact on the real economy should be fairly limited, at least for now.
Rate hiking cycles by the Fed can be seen as consisting of two phases. In the first phase, the economy is normalising after a crisis, while inflation remains subdued. As the economy strengthens, the Fed will at some point start gradually normalising monetary policy. At the very least, this is to build up a buffer in policy to be able to react to a future crisis. In any case, the rate hikes in this phase are not explicitly meant to fight an imminent inflation threat.
As the economic recovery matures, at some point inflation will start to pick up. At that time, the Fed will have to shift its focus from normalising policy to actually address inflation risks. Concerns about economic activity will then move to the background as the Fed really starts hitting the brakes. This second phase of the hiking cycle is a real issue for the economy and for financial markets.
This pattern is also confirmed in previous cycles. In the past 45 years, initial phases of Fed hiking cycles have seen the global economy strengthen further. Only later on in the hiking cycle economic growth really starts to slow down. For now, and probably for the whole of 2016, the Fed is clearly in this first phase. As such, the impact on the real economy should be fairly limited. This is likely to remain the case until inflationary pressures start to pick up. In any case, stay tuned…