INTEREST RATES IN USA FINALLY TAKE OFF!

By Ruma Dubey

Finally, the uncertainty ends. The waiting is over. Interest rates in USA have lifted off!

For the first time since June 2006, the US Federal Reserve has reversed the interest rate cycle – 0.25%.

This was very much on the expected lines; in fact it would be no exaggeration to say that the markets had more or less discounted the rate hike and today’s rise was more like in defiance.

The rates are up and now the real test begins. With the legs off the interest brake, we now for certain whether or not the US economy has actually improved. Let’s wait and see if people in US stop selling their houses and will instead go for remodeling, which will go a long way in reducing the inventory levels in the housing market. Hopefully once inflation kicks in, new houses will be bought once again. This 0.25% rate hike of today, will not have any effect on the housing market but if the gradual rate hike continues, we could see housing picking up. Today was merely a signal of the times to come.

At the ensuing Press Conference, Yellen said, “It’s the end of an extraordinary era and the rate increase reflects the Fed’s confidence that the U.S. economy will continue to strengthen.”

The bond markets had already anticipated this yet, once the Fed announced the rate hike, yields on US Treasury hit a 2 year high - the 2-year Treasury yield rose above 1%. The stock markets – S&P, Dow and the Nasdaq, first fell and then all were in the green. Gold pared its gains.

Without waiting for the most probable question in the Press Conference - why interest rates were hiked without inflation hitting its target; Yellen answered it herself saying, “Recent softness in inflation is due to “transitory” factors that are expected to abate. It takes time for monetary policy actions to affect future economic outcomes. Were the FOMC to delay the start of policy normalization for too long, we would likely end up having to tighten policy relatively abruptly at some point to keep the economy from overheating and inflation from significantly overshooting our objective. An abrupt tightening could raise the risk of pushing the economy into recession but the first rate increase “should not be overstated.”

A quick look at the highlights:

• Given the economic outlook, and recognizing the time it takes for policy actions to affect future economic outcomes, the Committee decided to raise the target range for the federal funds rate to 1/4 to 1/2 percent.
• The stance of monetary policy remains accommodative after this increase, thereby supporting further improvement in labor market conditions and a return to 2 percent inflation.
• Further rate hikes might be gradual – The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.
• In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its objectives of maximum employment and 2 percent inflation.
• The Fed officials voted unanimously for a rate hike, with not a single voice of dissent.

For us here in India, this 0.25% rate hike does not mean anything – it is more of a psychological thing. But now that it is over and done with, what lay ahead for the Indian markets?

Well, we are back to our own politics – 18^th we will know whether or not Sonia and Rahul will go to jail; that day will decide the fate of the Winter Session; it ends on the 23^rd and all eyes will be on whether the GST gets passed or not. If it does, markets will bounce back with great vigor and if it does not, well, we will once scout around for new triggers and start ringing off 2015.