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FED hikes ended zero-rate era

FED hikes ended zero-rate era

The Federal Reserve raised interest rates for the first time in almost a decade while signaling that the pace of subsequent increases will be “gradual” and in line with previous projections.

The increase draws to a close an unprecedented period of record-low rates that were part of extraordinary and controversial Fed policies designed to stimulate the US economy in the wake of the most devastating financial crisis since the Great Depression.

Why rate hike?

  1. The rate hike decision reflects the committee’s confidence that the economy will continue to strengthen.
  2. Rate hike was needed to increase inflation that in turn will boost investment.

Why low hike?

  1. It represents a compromise between policymakers who have been ready to raise rates for months and those who feel the economy is still at risk from weak inflation and slow global growth.
  2. The economic recovery has clearly come a long way, although it is not yet complete. Room for further improvement in the labor market remains, and inflation continues to run below our longer-run objective. Such cyclical weaknesses still exist. E.g.
  • The labour force participation rate is still below estimates of its demographic trend. Involuntary part time employment remains somewhat elevated and wage growth has yet to show a sustained pickup.
  • Another symptom of weakness is that inflation hasn’t reached the Fed’s 2% target since April 2012. The core version of the central bank’s preferred gauge of price pressures, which strips out volatile energy and food prices, was just 1.3% in the 12 months through October.
  • Gross domestic product expansion hasn’t topped 3% since the third quarter of 2010, on a year-on-year basis. It’s projected to grow 2.2% in the three months through December.

India & FED rate hike

  1. FED rate hike will encourage out flow of funds from emerging market, like India, in the short run, however, it will depend on
  • Earning environment of emerging economy
  • Domestic economic policy of that economy
  • Macro-economic conditions of that country

In case of India, it still provides better opportunity of earning than US economy and it has strong macro-economic conditions, so out flow of fund, if there is any, will be a short term phenomena.

  1. FED rate hike is an indicator of improving US economy, this will boost Indian export sector, specially the IT/ software sector, as their export will increase.
  2. Commercial borrowing by Indian companies will become a bit costly

Fed rate hike & ECB- Euro

  1. The US hike immediately started weakening the euro – a move which if prolonged would be a double-blessing for the ECB as
  • It boosted the currency zone’s exporters while
  • Simultaneously helping to kickstart inflation.
  1. Bond yields of euro zone members like Germany, France, and Italy had risen.
  2. The Fed and the ECB are moving in opposite policy directions because
  • The US economy has gained strength while Europe struggles with tepid growth
  • Employment condition has improved in SA while it is still high in EU.
  • Inflation rate is approaching US target while it is is far from the ECB’s target despite its best efforts so far to boost it.
  1. Indications are such that ECB is increasingly detached from FED policy:
  • Raising US rates could in theory have raised European borrowing costs so a counter-intuitive yield fall suggests ECB policy is increasingly detached from the Fed.
  • More ever, euro rates are driven by US rates only in the very short term. In the long term, 10-year Bond levels depend on ECB’s monetary policy.
  1. The ECB extended quantitative easing two weeks ago to prop up growth. But its move to shave 10 basis points off the deposit rate and extend but not substantially expand bond-buying was far less ambitious than expected, disappointing markets and pushing the euro more than 3 percent higher on the day.


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