By pointing to gradual rate increases, the Fed reassures markets and policymakers
The U.S. Federal Reserve has resumed normal monetary service by raising interest rates for the second time in three months. The Fed’s decision on Wednesday reflects its confidence in the continuing expansion and signals that its efforts to reflate the world’s largest economy are largely on track — with overall inflation seen to be stabilising around its longer-run target of 2% over the next couple of years. Significantly, Chair Janet Yellen stressed that policymakers expect the strengthening economy would warrant “gradual increases” in the benchmark federal funds rate to ensure that the monetary policy stance remains accommodative of growth, even as price stability is ensured. This emphasis on ‘gradual’ provides a degree of policy predictability that markets, for now, can broadly factor in two more rate increases of one quarter of a percentage point each for the rest of 2017 — especially when coupled with a median projection for the signalling rate to reach 1.4% at the end of the year, from the current 0.75%-1.0% range. The statement has allayed fears of an accelerated rate normalisation, that could have triggered a sharp jump in outflows from emerging markets such as India. Investors worldwide are bound to feel more reassured that one of the world’s key economic engines is in good shape and that should bode well for global demand. India’s exporters, including of software services, are also likely to see a silver lining in the Fed chief’s reference to a distinct firming in business investment, after having been soft in 2016, that has helped put business sentiment at “favourable levels”.
Ms. Yellen also flagged caveats to the Fed’s projections. Averring that policy is “not on a pre-set course”, she pointed to the potential impact that changes in fiscal policy, among other factors, could have on the economic outlook. While acknowledging that it is still too early to anticipate exactly how the Trump administration’s fiscal policies may unfold, the central bank is intimating that it will be closely monitoring the new dispensation’s broad budget plans and remains ready to change policy tack if it were to perceive any risks to its price stability goals. There is also the matter of when the Fed may decide to initiate the process of normalising its balance sheet. Given that the central bank’s holdings of Treasury bonds and mortgage-backed securities reached record levels in the aftermath of the 2008 financial crisis, any plan to begin unwinding these holdings will need to be very carefully calibrated and communicated in advance to ensure that global markets don’t witness a repeat of the ‘taper tantrum’ of 2013. Ms. Yellen stressed just that when she said the Fed “as a matter of prudent planning” had discussed issues related to an eventual change to its reinvestment policy and, while no decisions were taken, would ensure that the process be “gradual and predictable”.
The U.S. Federal Reserve has resumed normal monetary service by raising interest rates for the second time in three months. The Fed’s decision on Wednesday reflects its confidence in the continuing expansion and signals that its efforts to reflate the world’s largest economy are largely on track — with overall inflation seen to be stabilising around its longer-run target of 2% over the next couple of years. Significantly, Chair Janet Yellen stressed that policymakers expect the strengthening economy would warrant “gradual increases” in the benchmark federal funds rate to ensure that the monetary policy stance remains accommodative of growth, even as price stability is ensured. This emphasis on ‘gradual’ provides a degree of policy predictability that markets, for now, can broadly factor in two more rate increases of one quarter of a percentage point each for the rest of 2017 — especially when coupled with a median projection for the signalling rate to reach 1.4% at the end of the year, from the current 0.75%-1.0% range. The statement has allayed fears of an accelerated rate normalisation, that could have triggered a sharp jump in outflows from emerging markets such as India. Investors worldwide are bound to feel more reassured that one of the world’s key economic engines is in good shape and that should bode well for global demand. India’s exporters, including of software services, are also likely to see a silver lining in the Fed chief’s reference to a distinct firming in business investment, after having been soft in 2016, that has helped put business sentiment at “favourable levels”.
Ms. Yellen also flagged caveats to the Fed’s projections. Averring that policy is “not on a pre-set course”, she pointed to the potential impact that changes in fiscal policy, among other factors, could have on the economic outlook. While acknowledging that it is still too early to anticipate exactly how the Trump administration’s fiscal policies may unfold, the central bank is intimating that it will be closely monitoring the new dispensation’s broad budget plans and remains ready to change policy tack if it were to perceive any risks to its price stability goals. There is also the matter of when the Fed may decide to initiate the process of normalising its balance sheet. Given that the central bank’s holdings of Treasury bonds and mortgage-backed securities reached record levels in the aftermath of the 2008 financial crisis, any plan to begin unwinding these holdings will need to be very carefully calibrated and communicated in advance to ensure that global markets don’t witness a repeat of the ‘taper tantrum’ of 2013. Ms. Yellen stressed just that when she said the Fed “as a matter of prudent planning” had discussed issues related to an eventual change to its reinvestment policy and, while no decisions were taken, would ensure that the process be “gradual and predictable”.
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