Global stock markets cheer Federal Reserve rate hike, but deeper questions …

23 Dec 2015 | Author: | No comments yet »

Day 1 After Fed Liftoff Shows Move Catapults Money Market Rates.

London: Gold fell more than one per cent on Thursday, as the dollar surged after the Federal Reserve increased US interest rates for the first time in nearly a decade and hinted at more increases in 2016. 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. The move sent the dollar up to a two-week high against a basket of leading currencies, while spot gold dipped as much as 1.3 per cent to a session low of $1,058.44 an ounce and was down 1.2 per cent at $1,059.76 by 1405 GMT, less than $15 above a near-six-year low hit earlier this month. “The hints of further rate hikes moved the dollar because the market had priced in 2-3 more rate hikes in 2016,” Citi strategist David Wilson said.

With inflation nearly nonexistent and the job market still soft, many have wondered why the central bank would increase the cost of borrowing and risk slowing down growth. Gold has slumped nearly 10 per cent this year, largely on uncertainty around the timing of the rise and on fears that higher rates would hit demand for the non-interest-paying metal. “What we have seen this year in gold is largely going to continue but without the excitement of ‘will the Fed or won’t the Fed’,” ICBC Standard Bank analyst Tom Kendall said.

The rate, which signals where banks think they can borrow from each other, was posted by Intercontinental Exchange Inc. at 6:45 a.m. in New York at 0.3614 percent, the highest since March 31, 2009. Yellen had a few answers, most of which seemed to be geared at reassuring the public that the Fed is trying its best to avoid driving the economy into a ditch. 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. Gold is usually seen as an hedge against oil-led inflation and a lack of inflationary expectations removes another reason for investors to gain exposure to the metal.

In the leadup to the Fed decision, investors voiced skepticism that policy makers would be able to push rates as high as intended, because officials are using a new set of tools to engineer the move. The bank wants to move rates up slowly and gradually so that it can watch how financial markets react and make adjustments accordingly, which is easier to do if it starts doing this early, since monetary policy works with a delay. “I think it’s important not to overblow the significance of this first move,” Yellen added. “It’s only 25 basis points. Examining the results of decades-old monetary policies, though, may have limited value in comparisons with current economic conditions and investment risks. Broadly, the Fed should be fairly effective in draining excess reserves and that should put pressure on the front-end rates.” The fed funds rate opened Thursday at 0.35 percent, compared with the 0.14 percent open Wednesday, according to ICAP Plc, the world’s largest inter-dealer broker.

The Federal Open Market Committee voted Wednesday to set the new target range for the federal funds rate at 0.25 percent to 0.5 percent, up from zero to 0.25 percent. 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. When central banks do create downturns, she explained, it has typically been because “they have begun too late to tighten policy and they’ve allowed inflation to get out of control. Others argue that the economy is in a period of transition from being primarily an industrial economy to becoming a economy based upon information technology.

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. That is, in the early post-World War II period, the stimulus of the government, both fiscal and monetary stimulus, went into the real investment of the economy, creating more physical plant, equipment, and housing. And the downturn has served to lower inflation. “It is because we don’t want to cause a recession through that type of dynamic at some future date that it is prudent to begin early and gradually.” So that’s Yellen’s answer. Repo rates have been climbing this week ahead of the start of Fed tightening and amid the normal year-end volatility in money markets, as dealers shore up balance sheets.

But there’s another interesting theory about why Yellen, who was known as a monetary policy dove when she was appointed Fed chair, has chosen to start tightening when the economy still doesn’t seem to be at full health. 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. The Fed’s willingness for the time being to boost its reverse-repo facility, previously capped at $300 billion per day, means all the operations will come at the new fixed rate of 0.25 percent and ensures that should keep private repurchase agreement rates from dipping below that level. Reinhart writes: Hiking the funds rate, even as economic growth disappoints and inflation remains subdued, buys Yellen the credibility with her colleagues and market participants to subsequently tighten slowly. That is, Yellen positions herself now as a conservative central banker to ensure that she can be a compassionate one later by allowing Fed policy to remain considerably accommodative for a considerable time.

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. Yellen has a powerful voice as chair, but nonetheless has to convince her colleagues, some of whom are a bit paranoid about inflation, to follow her lead. But while this week’s move came with assurances that future increases will be “gradual,” it remains to be seen just how quickly — and how far — interest rates rise from here. “In the end, the pace will be determined by the data and financial markets developments,” Jim O’Sullivan, a Fed watcher at High Frequency Economics, said in a note to clients. “We remain skeptical that the pace will be as gradual as is being suggested.” A lot will depend on whether inflation continues to track within the central bank’s “target” range, or whether a tightening job market begins to put upward pressure on wages and overall inflation. 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. By showing she has the willingness to inch rates up now, she may be buying the ability to keep rates relatively low for the foreseeable future and stop the FOMC from doing anything rash down the line.

The latest thing here being the IMF’s inclusion of the Chinese currency, the renminbi, into the list of reserve currencies of the world, joining the elite circle of US, England, Europe, and Japan.

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