Wednesday, December 16, 2015
The Federal Reserve finally did it, hiking rates by 0.25% (25 basis points), with the upper bound of the target range of the overnight rate at 0.50%. The only interesting question is to see how the Fed intends to follow up on this hike, The interest rate projections published by the Fed are consistent with about a 100 basis point rise over the coming year, while there are 8 Fed meetings in 2016. The cleanest solution would be to hike rates by 0.125% every meeting, but it seems more likely that they would pause periodically.
In a normal world, the only people that would care about this are a handful of interest rate traders and possibly some academics specialising in monetary economics (and people who like reading about bond market economics). However, there is far too much attention paid to monetary policy, and the importance Fed moves are blown far out of proportion.
If this move has any significance, I would argue that it is bullish for the economy. The Fed is staffed with tons of economists, and is in touch with countless investors and business leaders. The fact that they hiked rates is a sign that they think the latest gyrations in risk asset markets is just the result of hyperactivity amongst market participants, and that the underlying economic trajectory is sound. (The fact that the upper end of the range is 0.50% means that it is not a resounding vote of confidence, admittedly.) Higher interest rates will have no measurable effect on the economy until they reach something like 4%.
Finally, there has been a lot of analysis discussing the size of the Fed's balance sheet. This analysis should have always been ignored. The Fed currently pays interest on reserves, it is in line with the operating practices of the other major central banks, and those banks have no problems whatsoever of setting the overnight rate independently of the size of their balance sheet. Admittedly, there can be divergences of interest rates amongst differing instruments, but this only matters for those trading those obscure instruments.
(c) Brian Romanchuk 2015