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The Fed Chooses To Hold; For Now...

In the build-up to yesterday’s announcement of whether the Federal Reserve would announce a rise in interest rates, opinion was divided between economic journalists and commentators. Interest rates have been at historically low levels since 2008 and there was considerable expectation of that changing this year.

However, the Federal Open Market Committee voted near unanimously—with only Jeffrey Lacker, president of the Federal Reserve Bank of Richmond, dissenting in a 9-1 vote—to keep interest rates as they are.

With inflation undesirably low, turmoil in China and depressed oil prices taking their toll on the global economy, the committee “reaffirmed its view that the current 0 to 1/4 percent target range for the federal funds rate remains appropriate.”

Stick rather than twist; at least for the time-being.

Federal Funds Target Rate

Even in their statement announcing that interest rates would currently stay as they are; the Federal Reserve indicated a willingness to make a change in the near future—possibly as soon as December this year.

If the committee sees “further improvement in the labor market” (despite the trumpeted low unemployment rate, there are currently over 94 million Americans not in the labor force) then we could still see an increase by the end of the year with there being reasonable confidence “that inflation will move back to its 2 percent objective over the medium term.”

Janet Yellen: Head of the Federal Reserve

The market reaction to the news saw stocks slump a little at the end of trading yesterday with the S&P 500 dropping by -0.26 percent and the Dow Jones Industrial by -0.39 percent. With volatility set to abound for the near future at the announcement, it was no surprised that CBOE Volatility Index was up 10.93 percent.

Considering more than just the job market though, China’s struggles since the devaluation of the Yuan and the revelation of less-than-accurate financial reporting previously has caused the U.S. dollar to further appreciate in value. That means a decrease in American exports and a rise in imports. The stalling of a rate increase could be an attempt to avoid the dollar becoming even more attractive with higher interest rates on Treasury notes.

There has been somewhat of an inverse correlation between the Chinese market and the ^VIX so far this year

How can we expect the markets to react though when we do see a rate increase—especially if that was to take place before the year end? Despite stock prices typically being erratic just prior to and following rate hikes, one year later the market has been up 6 percent on average.

While the obvious repercussions of a future rate increase are an increase in credit card and non-fixed rate mortgage payments, as well as saving accounts paying out a little more to customers (from an utterly trivial amount to slightly less trivial amount), it will also likely give a greater incentive to banks to increase their lending to customers.

Wariness around the domestic job market too is tied to the fact that a rate hike will likely see the hiring rate cool a little too. However, with the Reserve’s softly-softly approach it is doubtful that this would be to a particularly substantial degree.

The job market has improved but that recovery has been spotty.

The Federal Reserve does seem intent upon raising rates as soon as they deem it possible to begin taking the path of normalization for the economy. However, their reluctance to raise the week could signal an economic outlook that could be weaker than expected, as seen by the slump in stocks already.

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