Home / News / World /  The Fed rate hike that wasn’t and conclusions thereof

New Delhi: The muted reaction of the market the day the US Federal Reserve kept rates unchanged is a relief after the turbulence that roiled stocks last month. But the market’s apparent meekness on such a big day may not be as encouraging as it looks. The Fed’s decision not to raise rates, combined with statements made by Fed officials on Thursday, may have deepened investors’ fears about the strength of the global economy—and raised new questions about the Fed’s ability to respond to weakness around the world.

The decision to hold rates at zero to a quarter of a point suggests Fed policymakers remain fearful of crushing a recovery that they have gone to huge lengths to nurture, as they assess fierce headwinds from overseas. These include a 15% rise in the trade weighted dollar in the past year, volatile financial markets, weakening emerging market growth, and signs of a sharp slowdown in China’s economy.

Fed chair Janet Yellen expressed worries about turmoil in financial markets and concerns about the global economy. Economists who had argued against a Fed move had cited such worries, arguing that a rate increase could amplify instability (in emerging markets), potentially serving to undermine US growth. “This is positive for emerging markets. Even though a small increase in rates might seem trivial, it can cause big ripples, if not floods," wrote Brian Jacobsen, chief portfolio strategist at the $250 million Wells Fargo Advantage Fund, in a note.

The editorial board of the New York Times endorsed the Fed’s move. “By holding steady, the Fed is acknowledging, correctly, that the economy shows no signs of overheating… The Fed also acknowledged the dampening effect global economic weakness and financial-market volatility may have on the American economy."

The Fed’s decision was perfectly justified, said the New Yorker as well. As it interprets its legal mandate, its job is to maximize employment growth in a manner consistent with an inflation target of 2%. Despite the fact that job growth has been steady and the unemployment rate has fallen to 5.1%, which is close to the level at which the Fed believes inflation starts to accelerate, there is absolutely no sign yet of inflation picking up. To the contrary, headline inflation is running at an annual rate of just 0.2%, and last month consumer prices actually fell a little. Core inflation, which excludes volatile food and energy prices, is running at 1.8%, which is also below the Fed’s target. Even if you’re an inflation hawk, it’s hard to argue that the Fed needs to act now.

When asked specifically about the undershooting on inflation, Yellen said she and her colleagues aren’t too worried. Inflation will be very low this year, true, but it will inevitably accelerate next year as the labour market tightens further and the impact of a stronger dollar dissipates.

They could be wrong about inflation, of course, but for now Fed officials appear to be reasonably confident that disinflation won’t persist, and that means they’re still on course to raise rates this year.

However, though the Fed seems focused only on the side of what good low interest rates produce, it appears completely blind to the good that could come out of raising rates. For instance, higher rates would increase the income of savers, boosting consumer spending, and may help make credit more available to small businesses. Read more

What next?

While the “dot plot" of interest rate forecasts indicates that most officials still reckon the Fed will lift interest rates off their record lows this year, three members of the Federal Open Market Committee thought they would stay their hand until next year, and one even predicted an interest-rate cut this year. Jeffrey Lacker, the Richmond Fed head, was the only one who voted to tighten monetary policy.

Underscoring the lower-for-longer view, updated projections showed that Fed officials expect to raise their target range on overnight rates just once in their two remaining meetings this year. And several were calling for no change.

“It felt like a dovish result with a dovish statement," Carl R. Tannenbaum, chief economist at Northern Trust in Chicago, was quoted as saying by The New York Times. “Before this meeting, there was a supposition that they’d set the table for a future move. I didn’t see any silverware in this announcement, and I think October is off the table."

Still, other experts argued that the central bank is prepared to move as soon as global conditions improve, illustrating the uncertainty that will persist until at least the next Fed meeting in late October—or more likely until the last gathering of the year for policy makers in mid-December.

Ian Shepherdson, chief economist at Pantheon Macroeconomics, told NYT that he expected the US economy to continue to strengthen in the months ahead while volatility lessens in China and other markets, prompting the central bank to finally start tightening in December.

But the Fed’s move has big implications beyond today. So what should long-term investors in the US do now? CNN Money tells investors to be wary of bankers, among other things.

But the unchanged rates also bring good news for US investors. To start with, their credit cards and loan rates will stay cheaper for a little longer and getting a job may not be too difficult.

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