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Shai Heffetz

What's the deal with the Fed rate hike?

Markets are jittery ahead of an expected rise in US interest rates. But exactly when will the Fed rate hike occur, how big will it be, and how big an effect will it have? The President of the Boston Fed favours a slow and steady rate hike over several months, while analysts expect the first rise to come in December rather than September.

Market volatility continues amid hike expectations

Traders have been on tenterhooks regarding the much-anticipated Fed rate hike. With uncertainty growing over the timing and magnitude of the rate hike, markets have been more volatile as the September deadline approaches. The Fed is going to convene on September 16–17 regarding interest rates. A rate hike will encourage people to save more since the yield on invested money will increase, but it also discourages credit expansion which becomes more expensive.
It should be pointed out that the Fed’s recent Beige Book report was optimistic regarding the majority of sectors in the US economy. Continued growth across most sectors is expected. Strong manufacturing growth, retail sales and real estate performance have been reported. However, prices have been noted as ‘stable’ or up ‘only slightly’. It is the latter component that the Fed will be targeting if it decides to increase rates by 0.25 points.

Slow pace, steady rate hikes over time

Meanwhile, Eric Rosengren, the President of the Boston Federal Reserve Bank, has weighed in with what he believes is likely to happen: modest rate hikes over time. His dovish comments are predicated on weak global growth and increasing uncertainty vis-à-vis China’s equities meltdown. The FOMC meeting in September will be considering the first rate hike in nine years (since 29 June 2006) but market turmoil suggests the full impact of increasing rates on the domestic economy.
The Fed typically considers only the US economy when making its decisions, but the widespread global uncertainty is cause for concern. Chinese equities weakness, commodity price declines, emerging market currency crises and massive capital flight are all weighing on policymakers at the Fed and other central banks. While the US economy is largely on the right track, having added 1.5 million jobs in 2015, there is still concern that these successes could be reversed if incorrect policy decisions are made in the current economic climate.

Likelihood of a September rate hike at 27%

The Fed is aiming for a 2% inflation rate. For the 12 months ending in July 2015, prices across the United States increased by 0.3%. However, the Vice Chairman of the Fed, Stanley Fischer, is of the opinion that inflation will increase on the back of a strong US dollar and oil prices. The more uncertainty markets face, the greater the likelihood that a gradual increase in rates will take place.
The factors supporting a rate hike include:

  1. Unemployment holding at 5.3%
  2. Stable or steadily increasing prices
  3. Stanley Fischer has alluded to a rate hike
  4. Expansions in manufacturing and retail sales
  5. GDP increased at 3.7% (seasonally adjusted) in Q2 2015

Monetary policy is going to dovetail with labour market expectations while holding prices steady. However we should bear in mind that the energy sector in the US is declining – with oil and coal production markedly lower. Stagnant wage growth is a real concern with Q3 product growth coming in at 1.3%.
The Fed has pumped an estimated $3.7 trillion via its QE policies into the US economy, but inflation remains at historically-low levels. High debt levels, lack of savings and low levels of income characterise much of the US economy at present. Many economists cannot see the rationale behind raising interest rates on people who are still struggling to recover. Analysts have assigned a 27% likelihood of a rate hike in September, and the December figure is now at 60%.
Brett Chatz
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The content of this article is the personal opinion of the author and not The information and comments provided herein under no circumstances are to be considered an offer or solicitation to invest. Nothing herein should be construed as investment advice. The information provided is believed to be accurate at the date the information is produced.

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