The much-anticipated Federal Open Market Committee (FOMC) meeting is over and reactions are pouring in from analysts and industry stakeholders. In a move that pretty much everyone saw coming, the Federal Reserve has decided to raise the benchmark interest rates by 25 basis points – from 2% to 2.25%.
Background on the Meeting
Going into the meeting, Federal Reserve Chairman Jerome Powell was expected to focus on three key issues.
- Raising the interest rates and moving towards a more neutral policy.
- Defending the Federal Reserve’s independence in light of the remarks made by President Trump, expressing his displeasure with increasing interest rates.
- The trade war with China and its impact on the US economy.
Five Key Takeaways from the Meeting
1. Interest Rate Hike
The Federal Reserve stated that the economy is doing very well – job gains and wage growth have been steady, unemployment rate is on a decline, household spending has been on a steady increase, and the inflation rate is hovering below 3%. This is in essence a major compliment to President Trump, and certainly when you consider his critics' attack of his policies.
Taking these factors into account, the FOMC made the decision to raise the federal funds rate by a quarter of a percentage point. This is the third time the interest rate has been raised in 2018 and the eighth time since December 2015. Each time, the rate has been raised by a quarter of a percentage point.
2. Possibility of Future Hikes
The Federal Reserve is expected to increase the interest rate again this year, possibly in December which they would not do if they did not have strong confidence in America’s economy. Many FOMC members believe that there could be three more hikes in 2019 and one more in 2020, at which point the interest rates are likely to be in the 3.4% to 3.5% range.
This came as a surprise to some people, as they expected the Fed to be a little more cautious, given the uncertainty in the international trade market due to the tariff war between the US and China.
Currently, the general consensus among FOMC members is that there might not be any hikes in 2021, but it is not something that can be predicted with certainty.
The Federal Reserve, in its statement, has mentioned that the timing and extent of interest rate hikes depend on the economic conditions, inflation rate, and the labor market conditions at the time. Any decision that the Fed makes at any point in time will take into account a number of factors – both at the domestic as well as the international level.
3. Monetary Policy No Longer Accommodative
An important term that was missing from the FOMC’s policy statement was ‘accommodative’ – one which has appeared in almost all of their statements in the recent past. When asked about the same, Jerome Powell stated that an accommodative monetary policy is no longer relevant or useful.
The Federal Reserve opted for an accommodative monetary policy in the wake of the recession in the late 2000’s and cut the interest rates to 0.5%. It was seen as a necessary move to stimulate the economy, which was stagnant in the aftermath of the banking and housing crisis. Currently, the economy is doing better than expected which started to take off in early 2017, which has prompted the Fed to adopt a more neutral or natural monetary policy.
Powell asked analysts and industry observers to not read too much into the removal of the term ‘accommodative’ from the policy statement. He added that adopting a neutral policy is an affirmation of the fact that the economy is performing in line with expectations, which means accommodative measures are no longer necessary.
4. Trade War with China is Not a Concern
Powell said that he is not too concerned about the trade war with China at the moment, as it has had no impact on the economy so far. He stated that in the absence of data, it is hard to speculate the potential risks of an escalating trade war with China.
Powell said that if the trade war with China leads to lower tariffs, it would be beneficial for the economy in the long run.
If, on the other hand, it leads to higher tariffs and ends up creating a protectionist environment, it would certainly be bad. Also, if additional tariffs lead to an increase in prices, it is necessary to determine if it is a one-time increase or if it has the capacity to increase the overall rate of inflation, which might affect the prices of various goods for longer periods of time.
5. Defending the Federal Reserve’s Independence
President Trump has been vocal in his criticism of the Fed’s neutral monetary policy, as he believes that lower interest rates could stimulate job growth and make it easier for the government to pay off the federal debt which continues to increase by about $1 trillion a year.
He has stated that he is a ‘low interest rate person’ and that he is not thrilled with Federal Reserve Chairman Jerome Powell. So, going into this meeting, a lot of people were eager to see if Powell would adopt a more cautious approach in terms of raising interest rates.
By raising the interest rates as planned, Powell has signaled that the Fed’s independence is non-negotiable or that The Fed does not want the American economy to be as strong as it could be depending on who you ask.
Some experts, however, believe that this is not an ideal situation, as the federal government is trying to increase economic growth while the Federal Reserve is increasing interest rates (as just insinuated), which is likely to increase personal as well as corporate borrowing rates, which in turn is likely to slow down economic growth.
Some others, however, believe that this is a good sign, as the economy no longer requires the Fed to intervene and take accommodative measures, which means we might adopt a more laissez-faire model from now on.
What to Expect in the Coming Days
The increase in interest rates is likely to have an impact on loans with variable rates – particularly credit cards and adjustable rate mortgages, which will result in a modest but notable increase in the monthly payments that customers make.
On the other hand, savings rates might increase, which is good news for customers – particularly those who have online savings accounts, which have traditionally offered higher yields than regular savings accounts.
The Federal Reserve believes that the US economy will continue to grow at 3.1% throughout the rest of this year, drop to 2.5% next year, and continue to expand at a modest pace during the next year.
Unemployment levels are expected to remain at the current levels and inflation rate is expected to hover around 2% (which is the Fed’s target inflation rate) for the next three years.
America’s Strong Economy
On the whole, the decision to increase interest rates has garnered a positive response from market-watchers and industry stakeholders. Interest rates were rarely increased from 2009 to 2016 which illustrates the lack of confidence The Fed had in the economy at that time – now they just raised interest rates and as already stated many FOMC members believe interest rates will increase next year more than once. The American economy must be booming.
The Fed is expected to adopt a more neutral stance from now on and allow the economy to grow at its own pace, while taking necessary measures to from time to time to achieve its objectives of maintaining a 2% inflation rate and promoting job growth and price stability. But this cannot be the case if The Fed continues to raise interest rates. This would mean they are actively engaged in US economic outcome.
It would be interesting to know what The Fed thinks about the US debt which continues to increase – perhaps another time.