Even as equity markets within U.S. and Asia saw an upward trend immediately after the raise of the federal funds rates by the Federal Reserve, the first increase to be seen since June 29, 2006, Janet Louise Yellen said that the move will remain data dependent and strongly doubts having evenly spaced hikes in future. Wall Street has expected that the Fed was going to increase the rate, which has remained near zero for a long time, a move that is likely to have a wide implication on interest rates and global markets.
The long anticipated action of raising federal funds rates indicates that the U.S. economy has gained enough momentum to withstand elevated interest rates, said traders.
FOMC seeking to continue trend of raising funds in 2016
As the Federal Open Market Committee (FOMC) led by Janet Yellen increased federal fund rates, the ability to keep the trend in raising the funds in 2016 may be dependent on events happening elsewhere, economists at Bank of America Corp and HSBC Holdings Plc said.
HSBC’s chief global economist Janet Henry told clients that Fed policy will continue being steered by developments happening elsewhere. Henry further said that to keep things moving the direction Federal Open Market Committee currently projects; it implies that FOMC needs to be confident about the U.S. economy’s ability to withstand dis-inflationary pressures likely to occur elsewhere in the world.
There are many reasons to believe that inflation trends occurring at international levels will constrict American price pressures. As the oil slides below $35 a barrel, a figure recorded for the first time since 2009, commodities are beginning to renew their slide. Not only that, emerging markets are as well weakening while geopolitical threats continue to flare up.
Regardless of how sound the domestic labor market may perform, the U.S. inflation needs to be kept in check for weak import prices, soft foreign demands, and a strengthening dollar. The theory argues that globalization puts more competition for labor and goods thereby reducing international prices. Yellen and her central bankers team are keeping a closer look at these risks.
Global output the difference in world economy inflation
The central bankers already did calculate that the 15 percent rise on the dollar from June 2014 was signaling a point for rate hikes. The global output gap gauges the difference in world economy’s trends in relation to its actual expansion. When the gap is bigger, it means a weaker international inflation is likely.
The global output gap helps monitor overseas economic activity. Henry has estimated that the global divergence may widen to about 1.7 percent of GPD next year even as the U.S. economy strengthens and developing economies fade. Ergo, stripping out the U.S. could leave an international shortfall of about 1.9 percent.
When this is compared to what happened in 2004, it is a bit different. Back then, the U.S. and global economies were seen to be outpacing their trends. Fed last began increasing rates in 2004, and the previous time U.S. output gap parted with the rest of the world was when there was Asia crisis in 1997. The financial instability during that time tumbled down hedge fund long-term capital management something that resulted in cut rates by Alan Greenspan’s Fed committee.
HSBC however, feels that the Fed may have to revisit its thinking after its officials put the benchmark as 2.6 percent in 2017, during their September meeting. HSBC projects that the federal fund rates will not be higher than 1.5 percent by this time-frame.
Despite the Bizarre theory citing that Fed increases are likely to fuel inflation, a less sure Paul Donovan, who is an economist at UBS Group AG argues that local factors are still going to dominate inflation outside of commodities, thereby limiting the effects of a global output gap.
Chief European economist at Bank of America, Gilles Moec also warns that inflation is likely a global phenomenon that needs to fret all central bankers.
First comes national inflation then comes global
A study conducted by Moec’s team suggests that there has been a very tight correlation between the output gap and world’s inflation, according to statistical data that involved 23 developed countries and which was collected from 1960 to 2015. Moec said that the nation needs to generate sufficient output gap absorption on the local scene to offset the global capacity.
In an historic decision that saw the conclusion of a two-day policy gathering, the Fed said it was going to raise interest rates by 0.25 percent on short term from the near zero range. The economic activity had expanded at a moderate pace while business investment and household spending increased at solid rates in the recent months, said the central bank in a statement.
The statement also indicated that recent labor market indicators such as increasing jobs and declining unemployment were showing further signs of improvement and it is a confirmation that under utilization of labor resources seem to have reduced significantly since the start of this year. It was noted in the statement that inflation has been running below the 2 percent longer term objective by the Committee something that partly reflects declines in energy prices as well as prices of non-energy imports.
Following the Fed’s interest rates hike, there was a sudden shift in world trading markets. Soon after the Federal Open Market Committee presented its long waited rate increase, The S&P 500 gained about 29 points, or 1.45% to stand at 2072 while The Dow Jones Industrial Average hiked to 223 points, or 1.28% to stand at 17748. The Nasdaq Composite put in 75 points or 1.52% to stand at 5071. The only sector that showed negative shift was energy, but it later moved up. These immediate stock market changes later adjusted after the trading market euphoria.
Commenting on the decision by FOMC, Brad Friedlander of Angel Oak Capital Advisors said that Fed’s action was perhaps the right move. Angel Oak Capital Advisors has $6 billion worth of assets it manages for its clients. Brad Friedlander praised the FOMC team for sifting through data and seeing through the smog of credit-market jitters, rather than focusing on concerns within the marketplace.
Fed had the weapons to increase the rates at its September congregation; however, it opted not because of a swing of economic events that projected a downward risk to the economy such as the slowdown of China, weaker domestic data, and a stronger dollar.