Live analysis: Fed raises benchmark interest rate for first time in nearly 10 …

23 Dec 2015 | Author: | No comments yet »

Calm Acceptance as Fed Enacts Its First Interest Increase in Seven Years.

WASHINGTON — The Federal Reserve’s much-anticipated “liftoff,” its first interest rate increase since the financial crisis, unfolded as quietly and smoothly as Fed officials could possibly have wished. The long-expected but modest increase in the federal funds rate also boosted the dollar to a fresh two-week high against a basket of major currencies, while Wall Street snapped a three-day rally. Australia’s S&P/ASX 200 is down 1.4 per cent within the first half-hour of trade, while futures tip Japan’s Nikkei to climb 0.2 per cent and for Hong Kong’s Hang Seng to slide 0.1 per cent.

After a more than 1% post Fed rate-hike rally on Wednesday, Wall Street gave back gains on Thursday as renewed pressure from the energy sector forced U.S. equity markets substantially lower. “With the U.S. dollar strengthening, the subsequent sell off in commodities was inevitable as further pressure has been brought to bear on energy prices along with both base and precious metals,” Alastair McCaig, IG market analyst wrote in note. The stock markets cheered the Fed rate hike, but some economists saw the central bank as acknowledging how little it knows about where the economy might be headed. Brent and U.S. crude oil prices fell and remained near multi-year lows after fresh supply builds at the delivery point for U.S. crude futures added to worries about a global glut and strength in the dollar. The Fed statement hedged the possibility that inflation might not pick up much and acknowledged that global pressures could influence its choices going forward, said Charles Calomiris, a professor of economics and finance at Columbia University. Future decisions, the FOMC said, will be dependent on “a wide range of information.” That by itself is not informative, but a reading of the entire news release suggests that continued improvements in labor-market conditions will be critical to future rate decisions.

The Fed said on Wednesday that it would raise its benchmark interest rate to a range of 0.25 to 0.5 percent, ending a seven-year period of near-zero interest rates. The global headwinds stemming from difficulties in emerging economies such as China, Russia and Brazil could further suppress inflation and hurt hiring, possibilities that the Fed might struggle to model. “The Fed is much more uncertain itself about what is going on in the economy and willing to express that,” Calomiris said. “It doesn’t have a very clear model of how the economy is functioning.” Bank of America says it is increasing the prime lending rate to 3.5 percent effective immediately, while Citibank, M&T Bank and PNC Financial plan to make the change effective Thursday. Lower oil prices again weighed upon Wall Street, with Brent crude, the international benchmark, settling 0.9 per cent weaker at $37.06 a barrel after trading as low as $36.81 and reapproaching Monday’s seven-year low of $36.33. The oil woes helped push U.S. equities lower after rallying on Wednesday, with the S&P energy index .SPNY down 2.5 percent as the worst performing of the 10 major S&P sectors. “I think what we’re going to see through the end of the year is a refocus on oil and commodities,” said Karen Hiatt, senior portfolio manager at Allianz Global Investors in San Francisco. The Dow Jones industrial average .DJI fell 252.98 points, or 1.43 percent, to 17,496.11, the S&P 500 .SPX lost 31.16 points, or 1.5 percent, to 2,041.91 and the Nasdaq Composite .IXIC dropped 68.58 points, or 1.35 percent, to 5,002.55.

The moves in the market come just a day after a widely anticipated and long awaited decision by the Federal Reserve to raise short-term interest rates from a zero-bound range to 0.25% – 0.50%. MSCI’s all-country world index .MIWD00000PUS lost 0.7 percent, even as the pan-European FTSEurofirst 300 .FTEU3 index jumped 1.3 percent to close at 1,434.48. Economists at Goldman Sachs, in a note, said the Fed’s policy changes held very few surprises for Wall Street, and that’s partially why a blockbuster rally is unexpected in the days following the announcement. “The market reaction was limited, suggesting the policy and statement together were reasonably close to investor expectations. On Thursday, however, firms offered only $105 billion to the Fed — less than the $114 billion average daily sum offered to the Fed during testing over the last two years. Post-meeting rates in the overnight indexed swap market suggest investors expect the effective funds rate to settle at around 0.34% after liftoff, up from 0.15% in recent days,” the note said.

That analysis derives from the Fed’s continued belief in the Phillips curve, the theory that there is an inverse relationship between the unemployment rate and the inflation rate. However, yields on the benchmark 10-year Treasury notes US10YT=RR fell to 2.2322 percent, up 16/32 in price as investors turned their attention to timing of the next hike. Sanders — one of former Fed Chair Ben Bernanke’s least favorite politicians — is tapping into sentiment that the country has yet to fully escape the clutches of a recession that officially ended six years ago. “When millions of Americans are working longer hours for lower wages, the Federal Reserve’s decision to raise interest rates is bad news for working families,” Sanders said in a statement. “The Fed should act with the same sense of urgency to rebuild the disappearing middle class as it did to bail out Wall Street banks seven years ago.” Two other major consumer banks wasted no time in raising interest rates on their consumer products, following the Fed’s decision to raise interest rates. On Thursday, the Philadelphia Federal Reserve’s gauge of manufacturing activity for the mid-Atlantic region dropped solidly back into contraction territory as it tumbled to -5.9 from 1.9 the month prior.

In the first version, low interest rates have helped the economy build up some significant momentum, and the Fed needs to raise rates more rapidly to keep a lid on inflation and financial excess. Meanwhile, the number of Americans filing for first-time unemployment benefits fell more than expected last week to 271,000 from an unrevised 282,000 the week prior. Alternatively, low rates are necessary to preserve the modest pace of economic growth, and increasing them too abruptly could push the economy into recession.

Expectations were for 275,000. “In light of the firming of job growth since the October meeting, the [policy] statement significantly upgraded its assessment of labor market developments. It now notes ‘ongoing job gains’ and ‘declining unemployment,’ and says that underutilization of labor resources has diminished ‘appreciably,’” Goldman’s note continued.

The Fed’s preferred measure of inflation — an index of personal consumption that excludes volatile food and oil prices — rose just 1.3 percent in the 12 months ending in October. Yellen and other officials have argued that temporary pressures like the fall of oil prices and the strength of the dollar are suppressing inflation, and that the strength of the labor market is a more important indicator. If employment measures continue to improve and economic activity continues, in the words of the FOMC’s news release, to expand “at a moderate rate,” then there will be more such 0.25% moves. One risk to that scenario is mentioned in the release: “net exports have been soft.” The mere anticipation of the rate increase, plus weakness in other major economies, has already driven the dollar up on world currency markets. But be forewarned: Fed forecasts about economic growth have been notoriously inaccurate during the more than six-year recovery from the Great Recession.

The report, by the Office of Financial Research, however, said overall risks to stability remained “moderate.” Banks, too, are taking larger risks, according to a semiannual report published on Wednesday by the Office of the Comptroller of the Currency. The report said banks struggling to hit profit targets were loosening underwriting standards, particularly in high-growth areas like auto and construction lending. “In the area of credit risk, the warning lights are flashing yellow,” Thomas J. Markets are bracing for news about whether the U.S. central bank will raise rates for the first time in nearly a decade — and the path of possible rate hikes in the year ahead. Jeremy Stein, a former Fed governor who has returned to teaching at Harvard, has observed that higher rates have the virtue of addressing even unknown problems. This is a crucial sign that the rising inflation Fed officials expect to see might remain elusive, as cheaper oil undercuts the economy’s ability to achieve the Fed’s 2 percent target.

Banks were quick to take advantage of the Fed’s announcement on Wednesday to raise the rates they charge on many loans but not the rates that they pay to depositors. The increases came despite the news that U.S. industrial output fell for the third straight month in November, another sign that American manufacturers are under stress. The Fed’s Board of Governors will raise the interest rate paid on reserves to 0.5% and the FOMC will offer a rate of 0.25% on reverse repurchase agreements. Yellen, asked about that on Wednesday, suggested she did not see great reason for concern. “We have a far more resilient financial system now,” she said, “than we had prior to the financial crisis.” Though some in the markets question the ability of the U.S. economy to withstand higher U.S. interest rates, there is relief that the uncertainty over the Fed’s intentions is coming to an end. “Whether this optimism turns into a full blown Santa rally or not will depend on the Fed’s ability to manage expectations and reassure investors than the tightening cycle will be very gradual,” said Craig Erlam, senior market analyst at OANDA in London.

Hong Kong’s Hang Seng rebounded from a nine-day losing streak to advance 2 percent but gains were less robust on the Shanghai Composite Index in mainland China, which closed 0.2 percent higher. Tara Sinclair, a professor at George Washington University and chief economist at the jobs site Indeed, says hiring in both industries would likely be influenced by how quickly the Fed raises rates over the next year. Some experts say higher American interest rates could increase capital outflows from China, put downward pressure on the yuan and complicate Beijing’s efforts to avoid a sharp economic slowdown.

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