When will the Fed begin to raise interest rates?
Six and a half years ago the Federal Reserve put its benchmark interest
rate close to zero, as a way to bolster the economy. But that policy is
expected to change.
It’s a “liftoff” – to use the Fed’s own term – that’s getting the kind of attention that space aficionados once lavished on NASA rockets. And the announcement, when it comes, will have lasting consequences (the last time the Fed raised interest rates, in June 2006, Facebook was mainly for college students and had one-tenth the users of Myspace).
The Federal Reserve’s decision to raise the federal funds rate, perhaps as soon as Sept. 17, will be akin to a doctor’s decision that a patient is well enough to be gradually taken off medication. The thinking inside the central bank is that the economy is finally healthy enough that borrowing costs should return to more “normal” levels to help keep future inflation from accelerating too much.
But it is a moment with challenges. It could send markets into a tizzy (if past experience is any guide), lead to a slower economic recovery and make it harder for workers to press for higher wages. For savers, it could signal higher returns, but those borrowing to buy a house or a car may soon have to pay more.
Since Dec. 16, 2008, the Fed has kept its benchmark interest rate at a range between zero and one-quarter percent. The move was announced in the gloom of the longest recession since World War II, as jobs were being squeezed out of the economy like a sponge. Ten days earlier, the government announced the United States economy shrank by 533,000 jobs in the previous month, the largest one-month loss since 1974. (The number was actually far worse; it was later revised to a loss of 765,000 jobs.)
Federal Funds Target Rate
Graphic shows the Federal Funds Target Rate previous to the December 2008 rate change; since then the upper limit of the Federal Funds Target Range of zero to 0.25 percent.
By pushing the rate to the floor, the Fed went as far as it could with its main tool for guiding the economy: setting a target range on the federal funds rate, or the amount banks charge each other for overnight loans. The rate is set by the central bank through its buying and selling of short-term Treasuries – I.O.U.s from the government – mostly in trades with commercial banks.
The Fed used other means to prop up the economy, notably buying mortgage securities and other bonds to help bring down long-term rates further. The strategy, known as quantitative easing, encouraged more borrowing and lending, led to a stock market boom and, the Fed contends, eventually helped bring about a sustained economic expansion. Convinced that it has done as much as it considers prudent, the Fed is no longer expanding the size of its balance sheet, which reached $4.5 trillion.
Still, while the economy has rebounded, certain aspects of the recovery – like the housing sector, work force participation, and hourly wages – are spotty at best. Since March, Fed officials have said they expect to raise interest rates sometime before the end of the year.
The most likely dates are Sept. 17, Dec. 16, or perhaps March 16, 2016. Those are the next scheduled news conferences by the Fed chairwoman, Janet L. Yellen; each follows a two-day meeting of the Federal Open Markets Committee, the Fed policy-making group that sets the target rate.
Ms. Yellen underscored those three dates in her news conference in June:
“The importance of the timing of a first decision to raise rates is something that should not be overblown, whether it’s September or December or March — what matters is the entire path of rates. And, as I’ve said, the Committee anticipates economic conditions that would call for a gradual evolution of the fed funds rate toward normalization.”
Recent turmoil in the global economy has added an extra layer of
risk to the Fed's timing. The slowing
Chinese economy and devaluation of the renminbi, the slumping
price of oil, jarring downturns
in the global stock markets and a
lower-than-expected jobs figure in
August have all prompted questions over whether this is the best
time for the Fed to raise interest rates.
Fed policy makers last met on July 28-29, before much of the recent tumult. After that meeting, they issued a statement saying that economic growth continued to meet their expectations, and so they continue to be on track to raise rates. Whether that will be in a few weeks or a few months remains to be seen.
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What Fed Officials Have Been Saying
Ever since March, when the Federal Open Market Committee dropped the word “patient” from its stance on raising the benchmark rate, Fed policy makers have used a standard line to describe the conditions that would warrant a rate increase:
“The committee anticipates that it will be appropriate to raise the target range for the federal funds rate when it has seen further improvement in the labor market and is reasonably confident that inflation will move back to its 2 percent objective over the medium term.”
Those two conditions – further improvement in hiring, and “reasonable confidence” that inflation will reach 2 percent in the “medium term” – have remained an unwavering (if somewhat vague) rule repeated in speeches, testimony and other remarks by members of the committee ever since.
Recent market turmoil, set off by China's currency devaluation, will undoubtedly play some role in the Fed's decision. On Aug. 26, William C. Dudley, the influential president of the Federal Reserve Bank of New York and a member of the Federal Open Markets Committee, said that the case for a rate increase in September had become “less compelling to me than it was a few weeks ago.” But he suggested that action in September remained a possibility if markets regained their equilibrium.
Later in the week, Stanley Fischer, the Fed’s vice chairman, said the central bank was preparing to raise interest rates soon because of the “impressive” growth of the domestic economy. He suggested that the recent volatility of global financial markets could cause the Fed to hesitate, but only if it persisted.
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What Others Are Saying
As the mid-September meeting date nears, there seems no lack of analysts, experts and would-be Fed chiefs ready to tell the Federal Open Markets Committee what it should do. A sampling follows:
The Fed should act in September:
“Yes, it would be a little painful to start having to pay a little more for short-term borrowing and, yes, the net worth of Wall Street billionaires might increase at a slightly lower rate, but it looks as if the moment is at hand to end the morphine drip.”— William D. Cohan, author of three books on Wall Street, writing in an Op-Ed column (Aug. 28)
The Fed should wait:“With credit becoming more expensive, the outlook for the Chinese economy clouded at best, emerging markets submerging, the U.S. stock market in a correction, widespread concerns about liquidity, and expected volatility having increased at a near-record rate, markets are themselves dampening any euphoria or overconfidence. The Fed does not have to do the job. At this moment of fragility, raising rates risks tipping some part of the financial system into crisis, with unpredictable and dangerous results.”— Lawrence H. Summers, former Treasury secretary, writing in The Financial Times (Aug. 23)
A rate rise is overdue, but the Fed must be very cautious:The Fed seems intent on raising the rate “if only to prove that they can begin the journey to ‘normalization.’ They should, but their September meeting language must be so careful, that ‘one and done’ represents an increasing possibility – at least for the next six months. The Fed is beginning to recognize that six years of zero bound interest rates have negative influences on the real economy.”— William H. Gross, a co-founder of Pimco who now manages a fund at Janus Capital, writing in his September Investor Outlook (Sept. 2)
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Scars of ‘Taper Tantrum’
“Central bank communications can be a tricky business.”
Stanley Fischer, the vice chairman of the Fed, was referring to a remark in 2013 by Ben S. Bernanke, who was the Fed chairman at that time.
Mr. Bernanke, noting improvements in the economy, said in a news conference that the Fed’s policy makers believed the time would soon come to begin tapering the bank’s "quantitative easing" asset purchases.
The announcement had an instantaneous impact on markets that were caught off-guard after having grown accustomed to a Fed with an open wallet.
While the news conference was still underway, bond prices plummeted and stocks sank. As Gennadiy Goldberg, an analyst, said at the time: “As soon as you give the market anything to chew on, they are going to tear the limb off.”
Ms. Yellen and other Fed officials have learned their lesson from that episode, and have gone out of their way to provide plenty of advance warning about the coming rate increase. When rates eventually rise, in September or December or later, Ms. Yellen wants to make sure investors saw it coming. She has also made clear that future rate increases will be gradual, about one percentage point per year.
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The Futures Markets Place Their Bets
The market is leaning toward an initial rate increase in December rather than September. That’s the latest reading provided by CME, the derivatives marketplace, which allows investors to buy 30-day futures contracts on the federal funds rate. It uses these bets to create FedWatch, a tool updated daily with implied probabilities of Fed action on the rate.
For the Sept. 17 meeting date, the site on Sept. 3 was showing only a 27.4 percent chance of a rate increase.
But for the December meeting, futures traders saw a 58 percent chance of a rate increase.
And by the March 2016 Fed meeting, the likelihood reached 73.9 percent.
source: http://www.nytimes.com/interactive/2015/business/economy/fed-interest-rates.html?_r=0