Wednesday, 17 December 2014

Federal Reserve To Start Raising Rates In March or April

The Federal Reserve at its meeting today has made it clear that it will start raising official interest rates in March or April next year.  When it started to taper its policy of Q.E., the Fed stated that it would begin to raise rates only after "some considerable time" after the policy of Q.E itself had ended.  Questioned about what "some considerable time" meant Fed Chair Yellen, stated that it meant around six months.  But, the policy of QE ended in October, and yet the comment that rates would not be raised "for considerable time", remained in its monthly statements.  The implication was that this six months was being continually pushed out each month.  A change of wording was thereby required.

Speculation was ahead of the Fed statement, that the "considerable time" phrase would simply be dropped.  But, that could have sent a message that interest rates were about to be raised in the next couple of meetings.  That would have been a shock to the markets, at a time when financial markets are extremely volatile as a result of rapid shifts in the price of oil and other primary products, and when the extremely elevated levels of all markets, be it bonds, shares, or property mean that at some time, a very large sell-off is inevitable.

Rather than simply remove the words "considerable time", therefore, the Fed replaced the phrase with another, which stated that they could be "patient" in beginning to raise rates.  This raised the question of what "patient" means, just as the question of what "considerable time"  had done previously.

Chair Yellen clarified this in her subsequent press conference.  She made clear, as stated above, that the term "considerable time" was no longer relevant, given that QE had ended in October.  But "patient", she went on to say, was intended to convey that no change in policy had occurred, i.e. there was no reason to bring forward the date at which interest rate hikes begin, from what had previously been envisioned, for example, because the US economy has seen increasing growth in recent months, nor indeed to push the date further out, for example, because of low levels of inflation, and falling oil prices.

In other words, the original view was that rate hikes would begin six months after Q.E. ended, and that took them to April next year, and there was no reason to change the view that rate hikes would begin by that time.  Chair yellen also made clear that that was the case in her press conference, saying specifically that "patient" meant that they saw no reason why they would begin raising rates "in the next two meetings".

That means that interest rate hikes could begin in line with the original timescale of six months after the end of Q.E., around April.  In fact, Chair Yellen was even more explicit than that, saying that although they saw no likelihood of raising rates within the next two meetings, their decision remained data dependent so that the actual timing of rate hikes could be brought forward if the economy began to move ahead more strongly, just as if their was some unforeseen shock to the downside, this schedule could be pushed out further.

The financial markets may not want to see it - the Dow Jones Index spiked to be up nearly 300 points, when they saw that there was still a reference to "considerable time" in the statement - because they have become addicted to the drug of lax monetary policy to keep the various financial bubbles inflated, but the fed has given the clearest indication yet, that it is likely to begin hiking rates after its next two meetings.  In other words, official US interest rates will be going up in all probability in March or April of next year.

That is all the more likely given that US survey data in the last couple of months points to an acceleration in the pace of economic growth, despite the effects of the three year economic cycle that has caused a slow down in the EU, China and elsewhere.  The effect of the falling oil price is also likely to act as a significant stimulus to growth.  It is calculated to represent something like a $1 trillion tax cut to US consumers, who will have that revenue available for spending on other commodities.

One reason that the massive amounts of money printing has not caused consumer price inflation in the last couple of years, is that the velocity of circulation has slowed.  This acceleration in economic activity could reverse that trend.  A sharp increase in the velocity of circulation, as economic activity in the US rises sharply, with conditions of developing labour shortages in some sectors, and with the boost that significantly lower oil prices provides, could see inflation rise far more rapidly than the Fed itself currently anticipates.

That may not be sharp enough to cause the Fed to act earlier than March or April, but it certainly means that they will have no reason to delay action beyond March or April.

1 comment:

David Timoney said...

Though it's not the only factor, I suspect the decision of OPEC in November, not to cut production for at least 6 months, has led Yellen & co to firm up their anticipation of inflationary pressures building by April.