Will she, won't she?

All through the Summer, there has been speculation about whether or not the Federal Reserve would raise its policy rate for the first time in more than 9 years in September. This week it’s decision time for Yellen and co. For now, the odds on the first rate seem fairly even.

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More than two years ago, in the Spring of 2013, the Federal Reserve started a very gradual turn in US monetary policy. At that time, the then Chairman of the Fed, Ben Bernanke, started talking about reducing the monthly amount of bond purchases (the ‘tapering’). Ever since, there has been speculation about the timing of the real indication of a turn in policy, the first rate hike. Even now, more than six years since the end of the Great Recession the case for a rate hike remains far from clearcut.

Yes, the US economy has been recovering for the past six years and the unemployment rate has fallen back to a fairly ‘normal’ 5%. That said, there are still no signs of increasing inflationary pressures. The Fed’s favored inflation indicator (the core PCE deflator) has been easing for several years, and is currently just above 1%. Clearly, the US economy is nowhere close to overheating.

The strongest argument to start the rate hiking cycle now is that the economy is close to normal again, while monetary policy is still very far removed from anything even slightly resembling normality. In any case, the current economic backdrop at best warrants a very gradual normalisation of monetary policy with the pace of the hiking cycle fully dependent on the strength of the economy. This also seems to be the position of the Fed.

The exact timing of the first rate hike is an obvious focal point for markets. However, the fact that the era of free money is coming to an end is far more important than whether the first hike happens in September, October or December. In the past, turns towards tighter monetary policy have always been a source of volatility for financial markets. This time is not different, as recent turbulence in markets illustrates.

In previous cycles, equity markets continued their uptrend after the first rate hike. In spite of increased volatility, markets focus on the continuing economic recovery, which is the main reason for the rate hikes by the central bank. Irrespective of whether the Fed goes for a first rate step this week, or rather waits until December, this historic pattern is the most likely scenario for the next couple of months: a further uptrend in equity markets, but with substantial volatility.

 



This article was written by Bart Van Craeynest

on 14 September, 2015 about Blogs, Financial Markets, Intrest Rates, US & Canada

On completion of his studies in economics at UFSIA, Bart Van Craeynest started work as an economist in the financial sector. In this capacity he has been following economic developments in Belgium and internationally and the impact of the latter on the financial markets for over 15 years. Following a long period at a large bank, he became chief economist at a Belgian financial institution in 2010. Bart Van Craeynest has held the position of chief economist at Econopolis since 2015. He is co-responsible for the economic line of the house and hence closely involved in developing the investment strategy.