Fed rate increase that matters is the one after September

THE US FEDERAL Reserve Board has finally made up its collective mind and will probably tighten monetary policy in the United States before the end of 2015. But it is unclear if this will be real monetary tightening or just a gradual retreat from the previous easy credit approach, writes World Review expert Professor Enrico Colombatto. The Fed still has too much faith in Keynesian theorising and too many doubts about the strength of the US economy. Interest rates are likely to rise very gradually, in order not to wreak havoc in such delicate areas as private investments and banking. This cautious approach is more or less what financial markets have been anticipating. If these expectations are confirmed, US Federal Reserve Chairwoman Janet Yellen’s next moves will have little impact on the economy and international markets will not react. In the longer term, the satisfactory fundamentals of the US economy and adequate growth may be enough to persuade the Fed to stick to its new tightening course and, eventually, to adopt a less biased monetary view. Most observers expect the Fed will raise interest rates in September or December 2015, following up on its repeated announcements about the need to bring the era of easy credit to an end. During the first half of the year, the economy did not perform as well as policymakers had anticipated, which is the main reason why the return to normality did not start earlier. Since Ms Yellen has steadily hinted that tightening will definitely take place within the next five months, observers’ predictions are more than just an informed guess. At this point, the big question is no longer when the Fed will adopt a new policy, but how fast it will move and how long it will take to get the lending environment back to normal. In this case, ‘normal’ is a synonym for a lack of government interference in the credit market. The Fed’s anticipated move opens up a number of possible scenarios, depending on the pace and ultimate target of the interest rate increases expected to begin in a matter of weeks. The broad picture of the American economy looks brighter after the disappointing data of early 2015. Gross domestic product is expected to grow by 3 per cent this year, the unemployment rate keeps falling (to 5.3 per cent in June), the housing market is in good shape, and while the strong dollar has hurt exports, the damage to US producers from import competition has been modest. Consumption in the US has remained lively, especially spending on durable goods. It is quite possible that some industries are benefitting from the final months of ultra-cheap credit. Why wait until the end of the year to buy a car when the purchase can be financed today at fire sale prices? Yet it is fair to say that Americans now feel optimistic about the future of the economy, and probably rightly so. What should we expect in the short and medium run? Financial markets have already factored in the forthcoming tightening of monetary policy. For example, the prices of dollar-denominated, long-term bonds have already declined and will probably continue to do so. Yet they will not collapse unless the Fed opts for some kind of shock therapy, which is improbable, given its traditional prudence. By contrast, the stock market keeps treading water close to its historical record level, in defiance of those experts who have been predicting a more or less imminent crash since the Dow Jones Industrial Average climbed above 15,000 points in May 2013. The explanation is that most investors are not convinced that the disappointing first quarter data justifies extrapolation. They believe the fundamentals of the American economy are sound and that dips in stock prices are a buy opportunity, not the alarm bell before the crash. For a more in-depth look at this subject with scenarios looking to future outcomes, go to our sister site: Geopolitical Information Service. Sign in for 3 Free Reports or Subscribe.

RB metadata

ID: 

1438083302661789800