In yet another move contrary to the monetary policy trends elsewhere around the globe, the United States Federal Reserve chose to increase interest rates by another .25% to 1.50% this Wednesday. This week we would take a look at what motivated that decision, as well as what the consequences will be for finance.
To begin with, the increase in interest rates did not surprise anyone. The Federal Reserve has been gradually taking steps to phase out of the special set of protective measures it employed in order to deal with the fallout of the financial crisis of 2008. They have been bumping interest rates up by small increments for two years now. This particular hike was eagerly expected by investors, who began betting on a December hike since the summer. Following all news and economic reports from the United States, as well as previous Federal Reserve press conferences, the probability of the hike was at nearly 100% before it happened, so the markets were quite well-prepared for it.
As the chief regulator of monetary policy in the US, the Federal Reserve has been very careful and patient in its actions. Earlier in the beginning of the year the dollar seemed quite strong and many traders were hoping for a rate hike, but instead the Fed chief Janet Yellen chose to be cautious and really focus on the hard data. This patience finally paid off: currently the American economy boasts GDP growth, lower unemployment rates, and greater consumer spending, all signs of a healthy economy. Still, inflation and wage growth are not doing as well as expected, and the dollar itself remains quite vulnerable to the political struggles of Trump’s administration.
This most recent interest rate hike was the last major decision Fed Chief Janet Yellen was to make. In March she will be stepping down from the post in order to be replaced by current Fed governor Jerome Powell, who has supported Yellen’s policies every step of the way. It is widely expected that Powell’s leadership will echo Yellen’s approach and continue very carefully. The Federal Reserve announced that there will likely be three more rate increases in 2018 and two additional ones in 2019, if everything is moving according to the forecasts. Nevertheless, this is not an easy job: despite economic growth, inflation remains below 2%, contrary to conventional economic theory, giving mixed signals to the Federal Reserve as to what their course of action ought to be.
It is also important to mention that usually when a country increases its interest rates, its currency will gain in value compared to others. However, this didn’t really happen for the dollar. On the one hand, this recent hike was expected with nearly complete certainty, so one could argue that the market had already accounted for it in the dollar’s value even before it happened. On the other hand, there are other factors which are upsetting the dollar’s status, namely President Trump’s struggles. Between low approval ratings, the failure of his healthcare overhaul proposal, his baffling back-and-forth Twitter war with North Korean leader Kim Jong-un, and the most recent problems with implementing tax reform, especially after losing a senate seat from Alabama, Trump’s presidency in 2017 has been problematic, to say the least. As a result, the US dollar was unable to kick off against other major currencies, despite the boost from the Federal Reserve.