Summer is finally here; time for days at the beach, cozy campfires, and a Fed increase in the Interest Rate. Wait, what is that? An increase in the market interest rate?
As the months have rolled into summer, the United State’s Federal Reserve predicted that the benchmark Interest Rate (between .025 and .5%) in the market could be raised for the second time in six months. The last time this occurred was in December of 2015 when the Fed upped the rate by a quarter-point. A meeting of Federal Reserve officials that consists of 17 members from different states, in which 10 hold votes, was set to meet on June 14-15, in which raising the interest rate would be the main course in a financial feast.
Currently, the interest rate is particularly low, as chosen by the Fed, in order to promote economic success by urging borrowing and risk taking. After finding financial stability, the Reserve plans to raise the rate, which will reduce incentives but keep the economy going strong. The only problem that the Fed faces, is the market’s awareness of interest rate change. Instead of adjusting the rate based on what the market looks like at a particular pre-set deadline, the Fed wants to address the rate of adjustment based on data analysis of the current market. This would allow the Fed to increase or decrease the rate of interest based on currently surveyed data, making the adjustment process more reactive than preordained.
The flaw in this process is that the data can radically change and if the rate of interest changes based on reactivity, then there is a higher chance that the interest rate will be raised more often annually. According to an account of the Federal Open Market Committees Meeting in April 2016, they concluded,
“If incoming data were consistent with economic growth picking up in the second quarter, labor market conditions continuing to strengthen, and inflation making progress toward the committee’s 2 percent objective, then it likely would be appropriate for the committee to increase the target range for the federal funds rate in June.”
After meeting on June 14-15, the Federal Open Market Committee came out with their decision on whether to raise the interest rate or not. Federal Reserve chairwoman Janet L. Yellen said, “The FOMC maintained the target fund range for the federal funds rate at .025 to .5%.” Thus, it was evident that the interest rate was not going to increase like it did in December. She further explained, “This accommodative policy should support further progress towards our statutory objectives of maximum employment and price stability.”
This new approach that the Fed is experimenting is propelled by the by factors such as lower productivity growth and aging population. Andrew Levin, an economist from Dartmouth College said, “this means long rates can stay low without causing the economy to overheat, and thus the urgency to tighten is diminished.”
So what does this mean for us? This could mean an increase in potential job growth and wages. The U.S. hit a record low in the unemployment rate since 2007 at just under 4.8%. It also could support the expanding of the market and further the success of the global economy. Thus, there are many benefits that could come from this decision, and based on the current status of the economy, it looks as though it could be a successful summer.
After this post was written, BREXIT happened (British withdrawal from the European Union) happened.Some nations and cities may gain economic benefits from Brexit. In the wake of the vote, several global banks quickly began the process of shifting some operations out of London and into other European financial centres, including Frankfurt, Paris, and Dublin, in order to establish new legal domiciles in Europe in case London headquarters are no longer legally sufficient to serve the rest of the continent.
Brexit may also lead to increased real estate prices in New York. Many attorneys worry about the potential for contracts to be invalidated for Frustration of Purpose. Former Bundesbank President Axel Weber said that leaving the EU would not deal a major blow to London’s status as one of the top financial hubs.
On 24 June 2016, the bond and credit rating agency of Moody’s, on the basis of the result of the referendum, downgraded the UK’s standing as a long-term debt issuer and the country’s debt rating outlook from “stable” to “negative,” while retaining the overall rating of Aa1. Fitch Ratings degraded the credit rating from AA+ to AA because “uncertainty following the referendum outcome will induce an abrupt slowdown in short-term GDP growth…”. Standard & Poor’s cut the UK’s rating to AA, with the following comment: “In our opinion, this outcome is a seminal event, and will lead to a less predictable, stable, and effective policy framework in the U.K. … The negative outlook reflects the risk to economic prospects, fiscal and external performance, and the role of sterling as a reserve currency.” On the other hand, economic analysts have pointed out that the UK, as a fiscally and monetarily sovereign nation, retains the ability to service or retire, at any time, any part or all of the state debt that is denominated in the national currency, and, hence, there is no risk whatsoever of defaulting on that part of its debt.
In short Given the immediate market shock, the U.S. Federal Reserve likely won’t raise short-term rates for at least another year. “The probability of rate increases has been reduced through at least the end of 2017 as The Fed will need to take into consideration the strength of the global, in particular the EU/UK economies, against a backdrop of potentially a stronger U.S. economy with higher inflation,” Gerard Cassidy, an analyst at RBC Capital Markets, wrote in a recent report.