The Federal Reserve decided to raise its rates in a watershed moment for the global economy. Janet Yellen, the Federal Reserve chairman, said the decision marked “the end of an extraordinary seven-year period” of close to zero interest rates. “The US economy has shown considerable strength,” she added.
However, she qualified her view of the improvements in the US economy, stressing that “the process of raising interest rates is likely to proceed gradually”, news agencies reported Thursday.
The Federal Open Market Committee, which dictates US monetary policy, voted unanimously Wednesday night to lift the Fed’s interest rates for the first time since the credit crunch. It elected to raise its target for the Federal Funds Rate by 0.25 percentage points, from its previous 0% to 0.25% range.
The Federal Reserve succeeded in nudging borrowing costs higher and policymakers only needed to siphon $105 billion from money-market funds to achieve their goal.
The quarter-point rate boost rippled through money markets that are awash in nearly $3 trillion in excess cash that the Fed injected through bond purchases.
Central banks around the world had mixed reactions to the Fed’s first increase in short-term interest rates in nearly a decade, with most opting to increase their own borrowing costs or hold them steady.
The Fed said it would move forward gradually on rates as it monitors improvement in the US economy.
Anticipation of higher interest rates and stronger growth in the US has pushed up the value of the US dollar over the past year. That in turn has hit companies in emerging markets that borrowed heavily in dollars during the low-rate period. A stronger US currency is making it more expensive to pay off those debts.
Rise in Base Rates
A number of central banks reacted immediately to the Fed move with interest-rate increases of their own in a bid to keep their currencies competitive. Saudi Arabia, Kuwait, the UAE and Bahrain all raised their base rate in lockstep with the US move, while the Hong Kong Monetary Authority matched the Fed by raising its base rate by a quarter-percentage point to 0.75% from 0.50%. The territory’s currency peg to the US dollar ties its monetary policy to that of the US.
The Bank of Mexico also raised interest rates Thursday for the first time since 2008 to avoid further pressure on the peso after a sharp depreciation this year. Despite record-low inflation and relatively slow economic growth, the central bank lifted the overnight interest rate target by 25 basis points to 3.25%, in a move that most analysts saw as inevitable after the Fed tightening.
European Central Bank Governing Council member Ewald Nowotny on Thursday said the Fed decision doesn’t warrant an immediate reaction from the ECB. Nowotny said the Fed’s decision wasn’t surprising and was part of the ECB’s expectations that it had at its most recent meeting, where it decided to expand its quantitative-easing program.
Meanwhile, the central banks of Norway, Indonesia and the Philippines decided at their policy meetings Thursday to hold rates steady.
Another Southeast Asian economy, Vietnam, cut the interest rate of dollar-denominated deposits offered by local banks starting Friday in reaction to the Fed’s rate increase. The State Bank of Vietnam slashed the interest rate for dollar-denominated deposits to 0% from 0.25% for individual depositors in an attempt to discourage people from holding the US currency.
Stock Close Higher
US and Asian stock markets closed higher overnight while the Fed’s move was also greeted positively in Europe, with the major indices advancing by up to 3%.
Asian and European stock markets have shown healthy gains. London’s FTSE 100 Index posted its third successive day of gains as it recovered from an eight-day losing streak. It closed 41 points, or 0.7%, higher as investors cheered the certainty provided by the decision–and the Fed’s signals that it will be cautious about the scale of future increases.
Hong Kong’s Hang Seng Index jumped 0.8% overnight while in China, Shanghai’s composite index rose 1.8%. Japan’s Nikkei jumped 1.6%, South Korea saw gains of 0.4% and Sydney’s market was up by 1.5%.
On Wall Street, the S&P 500 equity index ended 1.5% higher at 2,073, about 0.7% above where it started the year. The technology-heavy Nasdaq Composite index also gained 1.5% while the CBOE Vix equity “fear gauge” was down 14.6% at 17.9 in late trade, well below its historic long-term average of 20.
Oil & Currencies
Brent, the international crude benchmark, settled at $37.19 a barrel, down 3.3%, and in sight of Monday’s seven-year low of $36.33. US West Texas Intermediate was 4.6% lower at $35.64.
The dollar index, a measure of its value against a weighted basket of peers, was last quoted at 98.33, up 0.1%, and not far off a 12-year high above 100.
The euro was down 0.2% at $1.09—off a high of $1.10—while the US currency was up 0.4% versus the yen at 122.16.
Gold held on to most of an earlier gain as it traded $11 higher at $1,070 an ounce.
Yield Choice
Other options, such as the tri-party repo market, offered yields above the Fed’s new 0.25% floor, giving money-market funds more attractive opportunities, said Peter Yi, director of short-term fixed income in Chicago at Northern Trust Corp., another Fed counterparty.
The Fed’s daily reverse repo borrowings will swell in coming weeks, and may reach $1 trillion next year, said Zoltan Pozsar, director of US economics at Credit Suisse Securities USA LLC in New York and a former researcher at the New York Fed and US Treasury.
As the Fed’s rate increase kicks in and money-market funds start advertising higher yields, they’ll probably lure away hundreds of billions of dollars from deposits in banks, which the funds will lend to the Fed through reverse repos, Pozsar said.
Within minutes of the Fed’s announcement Wednesday, banks nationwide raised rates for borrowers. Yet they kept deposit rates unchanged.
“It’s going to take about a month for the money fund portfolios to turn over,” Pozsar said. “When investors start seeing yields in the money funds go up and yields on deposits not go up, that’s when they are going to start to move money.”
