The long wait is over

So, finally, the Federal funds rate in the United States is not at zero. Instead of targeting a range of 0.0% to 0.25% for the Federal Funds rate, the Federal Reserve would target now a range of 0.25% to 0.50%. This is the first rate hike made by the Federal Reserve Board in the US in over nine years. The press release is here.

What are my take-aways from the press release?

(1) The word ‘only’ before ‘gradually’ was significant. That emphasis must have been the principal trigger behind the positive stock market reaction in the US after the rate decision.

(2) The Federal Reserve made a pointed reference to inflation undershoot as one of the factors that they would watch. If inflation stayed below 2%, they would probably go even slower on future rate hikes (“In light of the current shortfall of inflation from 2 percent, the Committee will carefully monitor actual and expected progress toward its inflation goal”). Of course, it is not impossible that they would look through the effect of falling oil price on the rate of inflation.

(3) The Federal Reserve also mentioned that they would track financial and international developments in determining the timing and size of future rate increases. Clearly, financial market volatility and international turbulence would hold them back, even if domestic economy was resilient

(4) They continue to reinvest their maturing Agency bonds and Treasury bonds and hence the Fed balance sheet is not shrinking. That is the key. The Fed balance sheet is not shrinking.

So, in the short-term, the equity market was correct to judge that the overall tone was dovish. But, the action in EURUSD is interesting this morning. That exchange rate moved lower.

Stocks are, of course, setting them up for a big fall in 2016. No change in that view, as far as I am concerned. Of course, this is not a investment recommendation!

This is a very useful Bloomberg article showing the dispersion of Fed governors’ interest rate forecasts and the state of the health of the US economy now compared to the previous two Fed tightening cycles on various parameters.

 

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