Monday, January 12, 2015

Expectations of rate hike in 2015

Entering 2015, most economists expected that the Federal Reserve would finally begin raising short-term interest rates. Fewer than two weeks in to the year and that thesis is already beginning to crumble.

For seven years, the Fed kept interest rates at rock-bottom levels and employed a massive money-printing program called Quantitative Easing in the hopes of boosting the money supply, expanding credit, and causing inflation to jump-start the economy (so the theory goes). Many experts have long waited for the Fed to “normalize” policy and raise rates, for reasons that include a desire to stop expanding the money supply, and wanting the Fed to have a cushion to lower them once again when another crisis occurs.

By the way, all this talk and debate about Fed policy surrounding “rates” actually only refers to one specific interest rate: the federal funds rate, that is currently at 0.25%. This is the rate at which banks and similar institutions trade their balances held at the Federal Reserve on an overnight basis and without collateral. In other words, this is the shortest term rate, and it is the only interest rate the Federal Reserve has direct policy control over.

The reason why analysts outside the small circle of institutions that actually interact with the federal funds rate care about it is so deeply is because raising or lowering it usually has a ripple effect in the same direction on all other longer term rates, like the discount rate, U.S. bond yields, and mortgage rates. Equity and debt markets, both domestic and foreign, are all affected by the raising and lowering of the federal funds rate.

Essentially, the Fed’s decision to raise rates has a real impact on every single person in the country, from the “bond kings” down to the hourly wage earners. But don’t count on that rate hike coming any time soon.