Federal Reserve Hikes Interest Rates

By The Fed FOXBusiness

After seven years of rock-bottom interest rates held low to stanch the bleeding from the worst financial crisis since the Great Depression, and after months of unusually public hand-wringing over the precise timing of liftoff, the Federal Reserve on Wednesday approved a rate hike intended to start easing U.S. monetary policy back to normal.

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The historic decision marks the final break from an era of unprecedented interventionist monetary policy initiated in the wake of the 2008 financial crisis.

The policy-setting Federal Open Market Committee voted unanimously to raise rates by 0.25% to a range of 0.25%-0.50%, not a whole lot but enough to test the still-weakened U.S. economy’s ability to absorb the higher borrowing costs that will follow the increase.

Citing healthy momentum in the U.S. labor markets and confidence that inflation is starting to climb upward toward the Fed’s 2% target, the Fed pulled the trigger on the first rate hike in nearly a decade.

"The Committee judges that there has been considerable improvement in labor market conditions this year, and it is reasonably confident that inflation will rise over the medium term to its 2% objective," the FOMC said in its statement released at the conclusion of Wednesday's meeting.

"Today is a solid first step in the Federal Reserve's efforts to normalize financial conditions," said Carl Tannenbaum, chief economist at Northern Trust in Chicago.

Tannnenbaum praised Fed officials for doing a "skillful job crafting a statement pleasing to all FOMC members" as well as market participants, one that "reassures markets that rates aren't going to get that much higher that much faster."

While the timing may have been "slightly late," according to Tannenbaum, "I think this timing will work out very well for the market and the economy." 

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With interest rates moving higher it will soon be more expensive for consumers to borrow money to buy big-ticket items such as homes, cars and appliances. Business will also pay more if they borrow to cover the costs for expansion and other capital investments.

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Those higher borrowing costs have fueled the Fed’s reluctance to raise rates off the near-zero range where they’ve been held since December 2008, just three months after the collapse of erstwhile Wall Street titan Lehman Brothers.

Lehman’s failure sent shockwaves through an already-fragile global economy and central banks around the world scrambled in search of emergency measures to wrench the world’s financial system back from the edge of the abyss.

In the U.S. the Ben Bernanke-led Federal Reserve unleashed an array of policies designed to pump money into a financial system on the brink, notably near-zero interest rates and a massive bond purchasing program known as quantitative easing.

By the fall of 2014, with the U.S. economy showing gradual signs of improvement, the bond purchasing program was phased out, a decision also attended by much hand-wringing and second guessing. Ever since then investors, economists, analysts and market participants of all stripes have been fixated on the timing of the first rate hike, fixated despite the concerted efforts of an array of Fed policy makers to emphasize that the trajectory of rate hikes was far more important than the initial liftoff date.

Fed Chair Janet Yellen, during a press conference that followed the release of the statement, sought to reassure consumers that the decision to raise rates was a vote of confidence in the health of the U.S. economy. "We see an economy that is on a path of sustainable improvement," she said.

While conceding some instances in which higher rates will make it more expensive for consumers to borrow -- pushing some credit card rates higher, for example -- Yellen noted that rates remain "very low and we've made a very small  move."

Earlier this year the Fed established two conditions for raising rates: “further improvement” in labor markets, and “reasonable confidence” that inflation is moving higher toward the Fed’s 2% target. Two consecutive months – October and November -- of strong labor reports have certainly shown “further improvement” in the jobs market, and recent hints that wages are moving higher are lending weight to predictions that inflation will soon be ticking higher as well.

Wednesday’s decision to raise rates indicates that the Fed believes the economy has fulfilled that criteria and is ready for higher borrowing costs.  

Now that the focus is off of the timing of liftoff, everyone’s attention will shift toward the trajectory of rate hikes in the coming months and years.

Fed officials have repeated unanimously and virtually in unison that rates will move higher “gradually” after the initial increase. And Wednesday’s FOMC statement made sure to emphasize that point, reiterating the Fed’s oft-stated position that monetary policy will remain “accommodative” for the foreseeable future.

"The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate," the Fed's statement said.

As they have in the past, FOMC members hedged their bets by saying the "actual path" of rate hikes will depend on the "economic outlook as informed by incoming data."

Analysts generally view the Fed’s definition of “gradual” as meaning possibly two more rate hikes in 2016 if the incoming economic data continues to provide evidence that the U.S. economy is gaining momentum.

“We expect two rate hikes between now and the end of next year. In addition to the expected rate increase this week, the Fed is likely to raise again in March, once we have more information about growth in the first quarter… Should the economy surprise on the upside in the first half, another rate hike in June is possible,” said Markus Schomer, chief economist at PineBridge Investments, ahead of Wednesday’s decision.

Schomer said the Fed is likely to avoid raising rates in the second half of 2016 as the presidential election heats up.

While no one has made the argument that seven years of historically low interest rates served as a panacea for the world’s global economic woes, nearly everyone agrees that the Fed’s muscular response to the 2008 financial crisis helped avert another Great Depression.

Beyond averting another depression, the impact of those low rates has been mixed and the long-term results remain to be seen. Savers, particularly retirees living off investments closely tied to interest rates, suffered under the Fed’s accommodative policies. Meanwhile, consumers benefited from the cheap borrowing costs, a dynamic that helped revive the badly-damaged U.S. housing market and the once-moribund domestic auto industry. 

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