Markets

The Fed rate hike: Why this is not the end of easy money

Lokeshwarri S K BL Research Bureau | Updated on January 19, 2018

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The US Federal Reserve has finally made the much-anticipated move, raising the target range for the Federal funds rate to 0.25 per cent to 0.5 per cent, from zero to 0.25 per cent. The FOMC members have also forecast that the target rate for the end of 2016 would be 1.375 per cent, indicating another 100 basis points hike over 2016.

Janet Yellen has managed the path towards monetary policy normalisation quite smoothly, if the reaction of financial markets after the move is any indication. The main signal that the move sends – that the US economy is now on a path of recovery -- seems to have buoyed the sentiment worldwide.

The first move has been made, but this does not mean that the era of cheap money is over. There are various factors that will ensure that adequate finance is available to companies and government, that are struggling, so that the feeble global economy is not derailed. One, while the Fed has hiked its target rate, it is no hurry to sell the bonds and other assets it has purchased as part of its quantitative easing programme over the six years from 2009.

The FOMC statement states, “The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction, and it anticipates doing so until normalisation of the level of the federal funds rate is well under way.”

This means that the Fed will ensure that the rate hikes are assimilated before selling those bonds and sucking out liquidity from the system.

Two, even as the Fed is on a rate hiking cycle, other central banks including the European Central Bank, the People's Bank of China or the Bank of Japan are in no hurry to follow suit. They will continue to infuse liquidity in to their economies; thus balancing the Fed’s gradual move towards normalisation.

Three, the rate hike made on Wednesday is far lower than the average Fed funds rate that has prevailed in US over the years. For instance the average funds rate between 1993 and 2000 was 5 per cent and between 2003 and 2006, the average rate was 3 per cent. The Fed is currently ensuring that rates remain far below these averages for some time in near future.

Published on December 17, 2015

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