What Does the March 2017 U.S. Interest Rate Hike Mean for The Markets?
The Federal Reserve announced a much-expected interest rate hike in March, the third increase since December 2015, and added 25 basis points to the Fed’s key rate. The new target range is now from 0.75 percent to 1 percent, with two more rate hikes almost certainly coming by the end of 2016. These developments are in harmony with the Summary of Economic Projections (SEP) which suggests a total of three hikes this year, followed by another three next year.
This means Fed believes that economic growth is picking up, and is more concerned about inflation. They are raising rates towards historically average levels, which exceeded 5 percent for most of the past few decades. Although the next few increases could push the key rate towards half the level of the historical average, it is evident that the Fed is returning to a traditional monetary policy after years of near-zero interest rates. The following chart shows the Fed funds rate since 2007.
The latest US job report showed the United States generated 235,000 new non-farm jobs in February, beating the expectations of 190,000 by Wall Street. The new report will be released on Friday, with a slightly lower expectation of 180,000 new non-farm jobs. With the unemployment rate at 4.7%, and inflation reaching the Fed’s target of 2%, it was almost certain a rate hike is on its way. But not all were convinced by this data. The Minneapolis Federal Reserve Bank President Neel Kashkari, questioned in his statement the necessity of a rate hike. Kashkari said in his statement that the labor market still shows signs of weakness and the inflation rate is still short of the 2 percent target.
The next weeks might be very exciting on the markets. It is generally accepted that a rate hike is bad for the stock market, and bullish for bond yields and commodities. Banks gain the most, as higher rates mean they are compensated more for lending. Construction and housing firms are usually hit the most, as higher borrowing costs prevent new construction projects. History shows that a week after a rate hike, on average since 1994, gold trades 0.13 percent higher, the 10-year T-Note falls 0.04 percent and S&P 500 loses 0.60 percent. The following graphic shows the US Government bonds on Thursday, April 6, 2017. The US 10Y yield increased 0.03% to 2.36% on Thursday April 6 from 2.33% in the previous trading session.
Another concern might be the U.S. dollar. An interest rate hike strengthens the US dollar due to reduced inflationary pressure. With Trump’s promise on tax cuts and fiscal stimulus, Fed would almost certainly need to hike faster, initiating a stronger dollar. Trump has already disapprovingly tweeted about a strong dollar, which would additionally raise an already record-high trade deficit. The currency markets didn’t react much today. As of this writing, the U.S. dollar traded at 1.065 per euro.
In the final months of his presidential campaign, Trump loved to rail against the Federal Reserve board’s chair, Janet Yellen. He claimed that Yellen artificially inflated the economy by keeping the Fed’s benchmark interest rate low, bolstering Obama politically. Former President Barack Obama appointed Yellen to the Fed board’s chair himself. “We have a Fed that’s doing political things Also, Fed officials announced that the huge balance sheet the Fed has acquired in bonds, amounting to $4.5 trillion, could begin shrinking later this year. According to minutes of the Federal Open Market Committee’s March 14-15 meeting released Wednesday in Washington,
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