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US Federal Reserve lifts rates and that is a good thing

Follow breaking news on the Federal Reserve at Markets LiveUS Federal Reserve lifts interest rates
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As the markets braced for a rate rise that didn’t come in September, Reserve Bank assistant governor Guy Debelle remarked that the first US rate hike in almost a decade would, when it came, be the most well telegraphed hike in history.

“If you’re not ready for it, you sure as hell have been warned,” he said, adding: “You’ve got no excuse.”

The fed didn’t announce lift-off then. It has now, and Debelle’s comment still applies. The Fed has lifted its key short term rate by a quarter of a percentage point from 0.25 per cent to 0.5 per cent, but its language is pretty much as expected, and there is no real reason for surprise, or panic.

The language used to describe the first rate rise in the United States since June 2006, and the first move in rates in any direction since December 2008 when the Fed took rates to zero-bound, makes it clear the Fed thinks economic conditions are strong enough to justify a rate rise, but only “gradual increases” thereafter – and even then, only if conditions permit.

In particular, the US central bank is watching inflation in the US closely. It is running below the Fed’s 2 per cent target, pulled down by low energy prices following the oil price dive in particular.

The Fed says that it expects inflation to rise to 2 per cent over the medium term, but says that “in light of the current shortfall of inflation from 2 per cent, the Committee will carefully monitor actual and expected progress toward its inflation goal”. That’s a clear statement that inflation is going to decide the arc of rate rises from here on. Rises will be gradual if they occur, and if inflation does not rise towards 2 per cent as the Fed expects, they might be delayed.

The Fed would be monitoring its forecast that inflation would rise towards its 2 per cent target “the way we expect”, Fed chairman Janet Yellen said at a press conference after the rate hike was announced, and the discovery that inflation was not rising as expected “would give us pause”.

This rate rise begins to lower the curtain on an aberrational period when super low rates created asset price distortions around the world.

Investors have piled into alternative assets since the global crisis pushed rates down towards zero as they search for yield. As US interests  edge up, the tide is turning, creating selling and price drops in some markets, including high yield corporate bonds. Shares and the dividends they pay also become less attractive as fixed interest rates go up.

This is therefore a time of undoubted risk for investors and the markets – the end “of an extraordinary seven-year period”  that began with the “worst financial crisis and recession since the Great Depression”, as Yellen put it at her press conference.

As Debelle said in September, however, this surely cannot be a decision that blindsides the markets. They should be prepared, and the bottom line is positive: the Fed is moving, finally, because it believes the US economy, the world’s largest, is strong enough to handle it. In that respect, the rate rise is more positive for the markets than a continued call by the Fed that rates needed to stay at zero-bound would have been.

By moving now the Fed is also doing what Central Banks always try to do. Anticipate what will happen, recognise that rate moves take time time to get traction, and adjust rates with the aim of extending and prolonging economic growth.

If the Fed did not move and “begin to slightly reduce” the amount of stimulus the US economy was getting, the risk would be that the economy would overshoot and force the fed “to tighten policy abruptly”, Yellen said at her press conference, adding: “It’s about a long running and sustainable expansion.”

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