The first rate increase since 2006 is first-rate, considering the alternative

23 Dec 2015 | Author: | No comments yet »

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

There was a rare consensus among brokers and market experts that the US Federal Reserve’s rate hike was a non-event for the Indian markets, with most saying a marginal increase had already been priced in. On the day the Federal Reserve implemented its plan to raise interest rates, driving up overnight borrowing costs, broader market forces conspired instead to drive other U.S. interest rates down.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.Shares of Red Hat Inc. gained in Thursday’s extended session after the open-source software provider posted results that beat analysts’ expectations.

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. Red Hat reported fiscal third-quarter earnings edged down to $46.9 million, or 25 cents a share, from $47.9 million, or 26 cents a share, a year earlier. 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. While the Fed’s first hike (in a decade) was on expected lines, there is no certainty about when and how it will move with respect to subsequent hikes.

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. As the head of research at a multinational brokerage firm points out, no one knows how the rate hike announced on Wednesday will impact the US economy. While the Fed can orchestrate a rise in its overnight target rate, buying and selling by investors worldwide largely dictate the movement of yields in the $12.8 trillion Treasury market, a forum that effectively sets the borrowing rates for everything from mortgages to corporate loans. 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. 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. Treasurys are being sought out by numerous sources now, thanks to soft global growth, regulatory changes that increase interest from banks and money-market funds, among other institutions, and investors and banks boosting cash holdings at a time when markets are broadly perceived to be fully valued and potentially vulnerable to a shock. 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. A recession in China remains the biggest tail risk for global investors.” Investors now think China’s growth is likely to slow to 5.5% by 2018 (down from 5.9% last month), the report added.

For central-bank officials, the divergence of bill yields from its policy rate was anticipated, but the longer it persists, the more it could be a cause of concern. 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. 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. The effort stands to be made more challenging by the crosswinds roiling economies and financial markets around the globe, including soft growth, rising debt burdens and a deepening commodity bust. 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.

Still, if the government is able to push ahead with reforms and there is greater evidence about the economy’s recovery, investors may still well flock to Indian shores for the lack of alternatives. Bahrain, Kuwait, Saudi Arabia and the United Arab Emirates each raised key interest rates Thursday to keep pace with the Fed, while Taiwan cut its benchmark rate to combat a recession. Traders said Thursday’s fed-funds rate opening level, up from 0.15% as of Wednesday, showed the market was reacting in an orderly fashion to the Fed’s decision to raise rates. Alternatively, low rates are necessary to preserve the modest pace of economic growth, and increasing them too abruptly could push the economy into recession.

In U.S. debt markets, Thursday was “business as usual,” said Garret Sloan, head of short-term fixed-income strategy at Wells Fargo Securities LLC. 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.

But “this may not be indicative of the dynamics coming into year-end and into 2016.” Some analysts took the divergence as a sign that money- market mutual funds, which handle cash for individual and institutional investors, were purchasing Treasurys in response to new rules forcing the funds to either focus on government securities or adopt a floating net asset value. 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. Thursday’s rise in the fed funds rate registered as a victory for Fed officials, but traders said they were on guard for the possibility of future lapses in money-market rates. Treasury Department has sought in recent weeks to take advantage of the low rates by boosting issuance of short-term bills, but demand continues to outpace the available supply, analysts said. “This is a very stable market; predictability matters a lot,” said Gabriel Chodorow-Reich, a monetary economist in the National Bureau of Economic Research at Harvard University, of money markets.

Rates on private-sector, overnight repo loans between brokers rose to 0.45% Thursday from 0.4% a day earlier, according to Wrightson ICAP, their highest since March. Money-market funds and other lenders on Thursday put more than $105 billion into a central-bank program designed to soak up liquidity in short-term borrowing markets. But be forewarned: Fed forecasts about economic growth have been notoriously inaccurate during the more than six-year recovery from the Great Recession. Keeping rates higher is expected to be particularly tricky at year-end, when many investors unwind longer term bets and move into short-dated securities and cash, and banks rein in their activities. “If they increase their policy rate, but all these other short-term market rates do not rise, I think they’d be disappointed,” said Peter Yi, who oversees about $230 billion of short-term fixed income products at Northern Trust Asset Management.

A federal agency said on Tuesday that credit risks were “elevated and rising” for American corporations and many foreign borrowers, even as investors are demanding significantly higher interest rates on junk bonds and foreign debt. 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.

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. 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.” 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.

Logan Wright, director of China market research for Rhodium Group, says Beijing’s need to control capital outflows would hamper the ability of policymakers to stimulate China’s slowing economy by cutting interest rates. Wright says “the potential for normalization of U.S. monetary policy should definitely be seen as a headwind for Chinese attempts to ease monetary conditions.” Low interest rates have been a boon for stock market investors for several years but Fed officials have telegraphed the likely decision far in advance.

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