What the interest rate hike means for us

23 Dec 2015 | Author: | No comments yet »

Editorial: Fed slams on the brakes prematurely.

The U.K. currency’s one-week implied volatility against the dollar headed for its biggest weekly slide since September after the Federal Reserve raised U.S. interest rates for the first time in almost a decade, ending months of speculation about the path of monetary policy in the world’s largest economy.

In his 1997 book, “One World, Ready or Not: The Manic Logic of Global Capitalism,” William Greider likens the global economy to a great machine, complicated and powerful, capable of both great creation and great destruction — but with no one at the wheel. Banco de Mexico’s board, led by Governor Agustin Carstens, boosted the overnight rate 0.25 percentage point to 3.25 percent Thursday from a record-low 3 percent, as forecast by 21 of the 26 economists surveyed by Bloomberg. Agustín Carstens, who also chairs the policy advisory committee of the International Monetary Fund, said Thursday the orderly reaction so far in emerging markets to the U.S.

Sterling dropped to an eight-month low versus the greenback Thursday after the Fed’s decision underscored the divergence in monetary policy between the U.S. central bank and the Bank of England. Federal Reserve’s rate increase could be sustained, noting that the coming moves will likely be less transcendental. “A very important thing is that this first step taken by the Fed had taken on a mystical quality, but I think that in subsequent actions taken by the Fed that characterization won’t apply,” said Mr. Mexican policymakers have been concerned that the long- awaited rate liftoff in the United States, Mexico’s primary trade partner and the world’s largest economy, could lead to capital outflows and financial instability in their country. Raising it essentially applies a brake to the entire economy, making it more expensive to borrow money for homeowners, small businesses, towns and school districts; depressing investment and, along with it, stifling job growth.

The central bank has spent about $24 billion in 2015 on intervention programs to support the currency. “The central bank has been watching the Fed very closely and preparing the market for this. The peso, the world’s eighth most-traded currency with a daily volume of $135 billion, strengthened after the widely anticipated Fed decision and closed little changed Thursday at 17.06 per dollar.

Other Latin American currencies, such as the Brazilian real, have also strengthened. “I think that for the time being the solid response can be sustained, but there is constant news that could have an impact on markets,” Mr. Thursday’s rate increase brings to an end an almost seven-year period beginning with Carstens’s predecessor, Guillermo Ortiz, in which Banxico cut rates 11 times as the economy struggled with the global financial crisis and its aftermath. Many economists anticipated that Mexico would follow the Fed after Banxico in July changed its meeting schedule for the rest of 2015 to be able to better react to U.S. moves. The Federal Open Market Committee unanimously 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.

It signaled that the pace of subsequent increases will be “gradual.” The peso plunged 23 percent in the past year and a half through Wednesday, reflecting the decline in oil prices and expectations for higher U.S. borrowing costs. Carstens, who ran unsuccessfully in 2011 to head the IMF and has left the door open to try again next year when Christine Lagarde’s term ends, praised the Fed’s handling of a process of monetary normalization that will gradually end the age of easy money that started after the 2008 financial crash. “The Fed is acting in a way that’s congruent with its mandate and with the communications it has been carrying out for many months. And even though the economy is chugging along far better than it was when the Fed reduced interest rates to the near-zero level where they’ve been for so long, it has yet to fully recover from the shock of a global financial collapse and the deepest recession since the Great Depression. In a ferocious column last September, New York Times columnist Paul Krugman said Federal Reserve officials talk to too many bankers, and bankers really, really want rates to go up.

The bank raised rates in a bid to keep the peso competitive, but annual inflation is at 2.2%, the lowest level in 45 years, and economic growth remains moderate. Sure, it’s cheaper for them to hold deposits, but bankers make money on the difference between what they pay on deposits and what they can charge for lending — what economists call the net interest margin.

He writes: “The appropriate response of policy makers to this observation should be, ‘So?’ There’s no reason to believe that what’s good for bankers is good for America. But bankers are different from you and me: they have a lot more influence.” There simply is no policy argument that can prove that intentionally slowing the economy right now is a good thing for anyone but bankers (and people with very, very large savings accounts; though the impact on savings interest rates is liable to be tiny compared to what happens to mortgage rates and other borrowing costs).

He argues that the Fed shouldn’t even consider a rate increase until both inflation and wage growth are above where they were before the financial crisis.

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