07/28/2016
An Interest Rate Hike May Happen Sooner Than You’d Think

An Interest Rate Hike May Happen Sooner Than You’d Think

Following a policy meeting at which officials concluded the economy has found more solid footing and risks have diminished, the Federal Reserve opened the possibility of an interest rate increase later this year, potentially as early as September.

Interest Rate Hike and a Flip Flopping Fed

For months, Fed officials have been fretting about a variety of risks, including a first quarter economic slowdown, subpar jobs numbers in May, Britain’s vote to leave the European Union, and long-term uncertainty about the outlook in China. These worries have delayed rate increases for months, raising doubts on Wall Street as to when rates will be lifted again. Officials are more confident they might raise rates at least once before the calendar flips to 2017 now that US economic data has improved and markets have settled following the Brexit vote. The Fed was silent on risks the past two meetings, indicating officials weren’t sure how to advance. By stating risks have diminished, it indicates a possibility, but not a certainty, of a rate increase in the months ahead.  

Cautious Optimism Reigns

In another mark of growing confidence, the Fed announced the labor market has strengthened since its June meeting. After just 11,000 new jobs created in May, hiring numbers bounced back in June with a gain of 287,000 jobs. Additionally, officials described household spending as “growing strongly” after solid retail sales data, and economic activity expanding moderately, a slight upgrade from its June assessment.

Markets Remain Skeptical

The optimistic assessment, however, did little to convince markets of a forthcoming rate increase. The probability in futures markets of a Fed rate increase sometime this year dropped from 50% before the statement to 42.7% after its release. The market echoed this skepticism, as gold and silver futures shot higher immediately after the release. Some market commentators have warned investors and fund managers of the danger of “playing chicken” with the Fed and betting against the dollar.

A Return to Interest Rate Normality?

Last December the central bank lifted the fed-funds rate a quarter percentage point, after keeping it near zero for seven years. The projection at the time was for a full percentage point increase in 2016, an estimate that is now all but out of reach. May’s weak jobs report, combined with uncertainty following the Brexit vote, delayed plans to raise the benchmark short-term rate. Chairwoman Janet Yellen had said an increase would be appropriate “probably in the coming months” depending on the economy and labor market. Nine of ten members of the Federal Reserve’s policy-making committee voted to leave the fed-funds rate unchanged. Officials will continue to monitor inflation indicators and global economic and financial developments. Focus has now turned to Ms. Yellen’s speech on August 26th when she could signal the likelihood of a September rate increase.

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