European shares rally after Fed rate hike, Casino slumps

23 Dec 2015 | Author: | No comments yet »

Fed interest rate hike: Wall Street dip curtails celebrationsWhat was all the fuss about, eh? WASHINGTON — The Federal Reserve’s decision to raise short-term interest rates for the first time since the financial crisis was, in its own words, a vote of confidence in the United States economy — even as much of the rest of the world struggles. But a CNBC analysis of six rate-hike cycles over the last three decades shows that rising rates were often accompanied by falling unemployment, rising stock prices and solid economic growth.

In addition to its benchmark federal funds rate, the Fed also hiked its interest rate on excess reserves and its rate on overnight reverse repurchase agreements by the same amount — 25 basis points. “This action marks the end of an extraordinary seven-year period,” chair Janet Yellen said in a question-and-answer session after the bank’s statement was released. “A modest increase is now appropriate.” That’s the Fed’s way of saying it thinks the U.S. economy is finally strong enough to start standing on its own two feet. The Dow Jones Industrial Average rose 22.35 points, or 0.13 per cent, to 17,771.44, the S&P 500 gained 2.38 points, or 0.11 per cent, to 2,075.45 and the Nasdaq composite added 14.93 points, or 0.29 per cent, to 5,086.07. Short-term rates will rise by about one percentage point a year — or 0.25 percentage points per quarter — over the next three years, Fed officials predicted. Economist Michael Gregory at BMO says Wednesday’s hike is a sign that rates are going to slowly rise only if everything goes according to plan. “The normalization process has begun, but policy rates are still going to be ‘low’ for a very long time,” he said.

It means a higher cost of borrowing for everyone from foreign governments and companies to home and car buyers, while also better rewarding savers on their bank accounts. The move is like “taking away the punch bowl just when the party’s getting started,” a quip coined by William McChesney Martin, Fed chairman from 1951 to 1970. For example, the current economic recovery has achieved a compound annual rate of growth of real GDP of 2.2 percent over the past six years and one quarter…twenty-five quarters. Germany’s DAX surged over 3 per cent, its biggest rise since August, and Britain’s FTSE 100 and France’s CAC 40 leapt 1.4 and 2.5 per cent respectively.

That was certainly the case in the early 1980s, when the Paul Volcker Fed attacked a protracted period of double-digit inflation with back-to-back interest rate spikes that sent the economy into a “double-dip” recession. Examining the results of decades-old monetary policies, though, may have limited value in comparisons with current economic conditions and investment risks. While things may be uneven across regions of the country and different industrial sectors, we see an economy that is on a path of sustainable improvement.” Still, the US recovery has been disappointing for many. One could argue that the Fed did a fantastic job in keeping the Great Recession from being anything worse than it was, but the efforts it made during the subsequent recovery, the three rounds of quantitative easing, did very little to spur on additional growth. So if they take markets off-guard, they get hurt themselves.” The rate forecasts, or dot points, from Fed members were a little higher than many expected, with 100 basis points of hikes pencilled in for next year and a terminal rate of 3.5 per cent.

That means people borrowing money from those banks have to pay more for some of their adjustable-rate mortgages, home equity lines of credit and consumer loans. Household incomes remain lower than they were a decade ago when adjusted for inflation, and wages have climbed only sluggishly even as firms hired back workers. Fed fund futures dipped in response, yet the December 2016 contract implies a rate of only 0.83 per cent, well below the 1.25 to 1.5 per cent favoured by the central bank.

But while it’s going to charge borrowers more, Wells Fargo announced no hike to its deposit rate — the amount it pays to savers when they store their money there. The latest rate-hike cycle also follows a period unlike any in the Fed’s 100-year history, when a global financial collapse forced U.S. central bankers to deploy extreme, untested measures — including a move to slash interest rates to zero and hold them there for seven years to revive a badly broken economy and severely damaged credit market. The Fed said monetary policy is still “accommodative after this increase, thereby supporting further improvement in labour market conditions and a return to 2 per cent inflation”. Now, after a recovery in both the U.S. job market and financial system — and months of warnings that higher rates were coming — Fed officials this week boosted short-term rates by a quarter-percent and said they expect that “economic conditions will evolve in a manner that will warrant only gradual increases” in this rate in the future.

In the months following the last six moves to raise rates, the jobless rate continued to fall — with the biggest job improvements coming in the recovery from the 1981 recession. Yet he doubted it would last given most other major central banks were very much in easing mode. “A follow-up Fed hike could come as soon as March, aided and abetted by favourable oil price base-effects that will lift inflation almost a percentage point and a potentially mild winter,” said Franulovich.

The Toronto market also saw a big jump, with the S&P/TSX composite index up 246 points, or 1.9 per cent at day’s end — its second straight day of 200-point increases. “The market as a whole is happy to get this first rate hike out of the way and potentially focus on other things, like the state of the economy,” said Scott Guitard, portfolio manager at Fiduciary Trust Canada. Rising interest rates push bond prices somewhat lower because bonds that were issued with lower yields pay smaller returns than freshly issued bonds paying higher rates.

Russian President Vladimir Putin said on Thursday he saw “no prospect” of improving relations with the current leadership of Turkey after Turkish forces shot down a Russian warplane on the border with Syria last month. The premium investors charge to buy Brazil’s sovereign bonds over US Treasuries continued to rise after Fitch cut Brazil’s credit rating to junk, the second ratings agency to do so this year. Mexico was waiting to see whether its central bank would follow the Fed by raising interest rates later, while there was also intense focus on how far Argentina’s peso would fall as it begins a new life as a floating currency.

Information technology is beginning to play a major role in the banking industry with changes in lending practices, like crowd funding, changes in payments technology, like Apple Pay, and changes in back offices and in investment practices. Myself, I don’t use a commercial bank for most of my banking and yet I can write all the checks I want, get all the loans I need, and get all the cash I want without having to do anything with a bank. As the Fed’s benchmark rate rises, mortgage rates and other long-term borrowing costs are likely to rise too, but the relationship is not mechanical.

Still, some analysts said they expected higher rates would begin to curtail economic activity fairly quickly, pointing for example to the auto market. Higher rates “will hurt borrowers and it will hurt the real economy because that’s what’s driving the auto industry right now,” said Mr William Spriggs, chief economist at the AFL-CIO.

The market is only discounting a total of four rate hikes over the two years. “Many commentators are taking comfort from the verbal guidance that the pace of tightening will be ‘gradual’.

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