Rate increase was right thing to do

23 Dec 2015 | Author: | No comments yet »

Cantillon: Fed’s rate rise failed to live up to the hype.

At least for the short run, the Federal Reserve’s interest rate increase has created one clear winner: the banks. Gold rose more than 1 percent on Friday, recovering from its biggest daily loss in five months as stocks and the dollar retreated, but remained near multi-year lows after the Federal Reserve lifted US interest rates.

When the Fed announced Wednesday that it would raise its benchmark rate to a range of 0.25 to 0.5 per cent, banks raised the rates they charge on many loans but not the rates they pay to depositors. The metal has recovered some lost ground after bottoming out on Thursday at $1,047.25 an ounce, within a couple dollars of a near six-year low reached on Dec. 3, after the first U.S. rate hike in nearly a decade. Fed officials on Wednesday unanimously backed an increase to the central bank’s benchmark interest rate target, lifting rates from near zero for the first time since the financial crisis.

The cheer with which the financial markets greeted the Fed’s rate increase – or rather the cautious comments accompanying it about the pace of future increases – ran out of steam quickly enough. By Friday “normal transmissions” had resumed on the markets, as weak oil prices and fears about economic growth led to equity prices falling back. EST (1910 GMT), while U.S. gold futures for February delivery settled up 1.5 percent at $1,065 an ounce. “There are big volatile swings but the overall tone is still lower,” said Bill O’Neill, co-founder of commodities investment firm Logic Advisors in New Jersey. As oil slipped again on Friday, investors seemed to be asking whether this was due to a glut in supply, or was it a sign that economic growth rates – and thus demand – were slipping.

The unemployment rate has held steady recently, at 5 per cent, but the underemployment rate — which includes the unemployed, part-timers who need full-time work and jobless workers who have apparently given up looking — is still at nearly 10 per cent. O’Neill added that weak stock markets also pressured bullion prices, with global equities falling on concerns about slumping crude oil prices that may be signalling slower growth. “The Fed, from its forecasts, is anticipating four rate rises next year. Many economists have latched on to March as the most probable, in part because that would coincide with Fed Chair Janet Yellen’s next scheduled press conference. With no evidence of inflation in wages or in consumer prices, there was simply no need at this time for the Fed to risk slowing the economy by raising rates.

Holdings of the world’s largest gold-backed exchange-traded fund, SPDR Gold Shares, fell another 4.5 tonnes on Thursday to 630.17 tonnes, the lowest since September 2008. Williams – who worked for Yellen when she ran the San Francisco Fed before handing the reins to him, and whose views are seen to align closely with hers – said his own view is in line with that expectation. But just because the Fed got away with one increase without leading to any great upheaval does not necessarily mean it can repeat the trick again in 2016. The Fed meets eight times a year. “You might immediately jump to the conclusion that it’s every other meeting,” Williams said, referring to the likely timing of next year’s rate increases. “But as we’ve learned over the last several years, the economy does not always perform as forecast.” Though much more optimistic about the economy than in prior years, Williams said that at the end of this week’s meeting, there was no round of high-fives among the 17 policymakers at the table.

Another rate increase could be on the cards in March or April, with a couple more slated in for later in the year, assuming the Fed sees the kind of economic growth it expects. For most of the past several decades, Fed policymakers tended to indulge these fears by giving priority to fighting inflation, even when doing so stifled jobs and wages.

To keep job creation strong, rates will need to stay low, rising only modestly next year, he said, adding: “We are going to run a higher-pressure economy for a while.” If the economy springs any surprises, he said, the Fed will respond as needed. The problem is that, to work, interest rate increases have to be slightly ahead of the economic curve, and the risk for equity markets will be if growth rates subsequently disappoint, or inflation does not pick up as expected. Yellen, in her news conference immediately following Wednesday’s decision, also emphasized that rate hikes, though gradual, would not necessarily be all a quarter of a percentage point or evenly spaced in the calendar year.

Chinese economic growth at 6.9 per cent in the third quarter is a whisker below Ireland’s GDP growth rate, having been up near double digits for a number of years. Recent comments by Janet Yellen, the chairwoman of the Fed, indicate that the increase is more to appease inflation hawks than to definitively change course. In the US, the recovery is now long-lasting, but it never seems to have reached full steam, while the euro zone still faces the familiar questions, even if the ECB has expressed optimism that its medicine is starting to work.

It’s like an army that’s got all of your forces out there, you don’t have a lot of reserves,” said Williams. “It’s hard to feel like, well, I’m feeling any kind of sense of victory or something.” In fact, the risk that wages will continue to stagnate — as they have for decades for most people — should be a far more worrisome issue for policymakers than a distant and theoretical risk of inflation.

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