The Federal Reserve Bank is set to hold a tow-day meeting on Tuesday to discuss its policy for the upcoming months. It is widely expected that the much anticipated announcement on interest rate increase will be made public Wednesday afternoon.
There is still somewhat of a debate over “when” the rate hike will happen, with most economists expecting it to be planned for June this year. Others suggest a more prudent approach from the Fed, and say nothing will happen until at least mid-September, when the Federal Reserve has another policy-making meeting planned.
Fed chief Janet Yellen will probably hold a press conference on Wednesday after the meeting. She previously said that the timing of the interest rate increase, although imminent, depends on how the economy performs.
At the moment, U.S. government bonds are on the rise and this keeps attracting foreign buyers. In Monday trading, the yield on the 10-year Treasury note was 2.088%, compared with 2.110% at the end of last week and 2.173% at the beginning of the year. As bond prices rise, treasury yields fall.
Since the European Central Bank started its bond-buying program this month, bond yields in European countries reached record lows, making investors to look to other alternatives such as U.S. Treasury bonds. They opted to do so since the recent dollar rally means foreign buyers will get increased returns of U.S. bonds.
Some of the concerns investors have been struggling with are that a higher interest rate might diminish the value of outstanding bonds. However, there is a general conviction among investors that U.S. yields won’t climb enough to make Treasury bond yields unattractive compared to their European counterparts.
The Federal Reserve Bank is expected to increase the federal funds interest rate to 1.125 percent before the end of 2015, as it was announced in December by its open market committee members. Many analysts have recently started to question that number, as the recent global economic context suggests a lower rate increase might be enough.
The sharp decline of the euro, constant low inflation and the recent US economic growth – as modest as it is, it’s still a good sign – all suggest no radical measure is necessary to protect the economy.
How will a rate increase actually change the economy?
Several economists have pointed out that the US economic recovery after the 2008-2009 crisis is in part owned to the low interest rate imposed by the Federal Reserve over the last six years. Ranging from zero to .25 percent, the Fed’s effort to get American economy back on track led to lower costs for car loans, credit cards and mortgages. A sudden rate increase might have the opposite effect and threaten the shaky economic growth.
Analysts say a rate hike will definitely occur, but they offer a lower number than the Fed’s December estimation, at about a quarter of a percentage point. “I can’t see why they would jump and move quickly. It certainly will be a big percentage increase from nothing to something,” Kenneth Rogoff, former chief economist at the International Monetary Fund, told reporters. Currently a Harvard economics professor, Roggoff believes the Federal Reserve will be very cautious not to prematurely block the recovery by trying to keep the inflation at low levels.
William Dudley, president of the New York Federal Reserve branch, estimated last month that “inflation is projected to stay for some time below the Fed’s objective of 2 percent” and advised for a “more inertial approach to policy.” In his approach, there is little risk in delaying any major rate hike, compared to what a significant interest rate increase might do to the economy if thing don’t go as expected.
Among the market sectors that would suffer as a result of higher rates, housing recovery will hurt the most, at least according to economist Sam Kater. “In the past the mortgage market could buffer the impact by switching to adjustable rate products. Now, that is not the case,” he claims.
Household debt greatly benefitted from low interest rates since 2008, reaching the lowest level since 1980. Economist believe a low rate increase would go unnoticed for households, but debt levels are still relatively high and long-term rate hikes might seriously hurt household savings.
How about investors? Well, the period before the Fed increases interest rates is historically seen by economists as a good time to invest. According to Forbes analyst Scott Minerd, “over the past six tightening periods since 1980, the S&P 500 has returned 23.5 percent on average in the nine months prior to the first rate increase.” He believes the circumstances are still the same this time, and the environment is favorable for investment. Investors have no reasons to get gloomy over the potential rate increase.
Federal Reserve officials admitted themselves that they embark on “unexplored territory” regarding the interest rate hike. Most of the market committee members showed they tend to be cautious on the matter, and most economist are starting to believe that any sensible rate increase will only happen after the economy will show firm signs of improvement.
Image Source: New York Times
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