Real Impact of Rate Hike is Still Far Off

Federal Reserve policy makers have sent mixed messages regarding both the criteria for and the timing of the first interest rate hike in nearly a decade.

One thing they’ve been unanimously unequivocal about is the trajectory: once rates start moving higher they will do so gradually.

So, despite the obsessive attention being paid to Thursday’s statement from the policy-setting Federal Open Markets Committee, the initial rate hike – whenever it comes – isn’t going to have a dramatic financial impact on the global economy. Not for some time, anyway.

In the first place, the move will almost certainly be an increase of 25 basis points, which would raise rates to a range of 0.25%-0.50% from their current range of 0%-0.25%. In other words, a minimal increase that would only slightly impact borrowing costs.

Bankrate.com’s chief financial analyst Greg McBride poetically described the initial hike as similar to “the first dusting of snow in late fall -- it will signify a change in seasons.” The actual impact on household budgets, he said, would be “almost inconsequential.”

Second, central bankers have made it abundantly clear that they’re in no hurry to push rates higher, and that cautious approach is not likely to change after the first hike is announced. A second rate hike might not happen for months.

Fed Chair Janet Yellen said earlier this summer, “Too much emphasis is placed on the timing of the first increase. What matters is the entire path of rates.”

One thing the Fed doesn’t want to do is raise rates prematurely and revisit mistakes made by other central banks. For instance, in 2000 the central bank of Japan raised rates slightly only to see the country slip back into recession amid a devastating bout of deflation.

Unsettled Debate

The debate ever since the Fed lowered rates to their near-zero range in December 2008 during the worst of the financial crisis has been how to balance the need for economic stimulus provided by cheap borrowing costs versus fears that low inflation will create asset bubbles and eventually lead to runaway inflation.

While that debate has hardly been settled, the need for economic stimulus has clearly been diminished as the unemployment rate has fallen to 5.1% from 10% in late 2009 and the economy continues to generate a healthy amount of new jobs each month.

“Of all the indicators that the Fed follows, employment data have shown the most improvement in the past few years. If the FOMC does decide to increase the fed funds rate this week, it likely will point to the labor market as a primary reason for the move,” analysts at Wells Fargo Investment Institute said in a note on Tuesday.

But fears that the Chinese economy is faltering sent shockwaves through global markets last month, a concern that could prompt Fed policy makers to delay raising rates if only to allow markets to settle down a bit.

Either way, any significant impact brought about by Fed rate hikes isn’t likely to be felt by consumers for at least a year, and probably much longer than that.