The US Federal Reserve raised its base interest rate. Fed rate: impact on the economy

Despite the protests of Donald Trump, the US Federal Reserve raised its key rate by 0.25 percentage points. – up to 2.25–2.5%. This is the fourth increase in the US benchmark interest rate since the beginning of the year and its highest value since the beginning of 2008. Investors were waiting for such a decision, but hoped that the Fed would take a break next year - after the speech of Fed Chairman Jerome Powell, the markets fell. For Russia, the Fed’s decision means increased pressure on the ruble, and in the longer term, a further increase in the Central Bank rate.

Read more. The Fed raised rates for the fourth time this year, to the highest levels in the last decade. In total, since the beginning of the monetary tightening cycle in 2015, the Fed has increased it eight times.

The Fed's decision completely coincided with economists' forecasts. If the rate were kept at the same level, the regulator would demonstrate that it depends on market turbulence and responds to pressure from Donald Trump, who since the last Fed meeting has constantly called on the regulator to change policy. On the eve of the Fed meeting, he wrote tweeted: “I hope the Fed reads today's Wall Street Journal opinion piece before making another mistake. Don't let the market become even less liquid than it is now. Get a feel for the market, no need to rely on meaningless numbers. Good luck!". The column mentioned by the president said that US macroeconomic indicators and financial market signals should push the Fed to take a pause in the rate hike cycle. But leaving the rate at the same level, the regulator would send the market a signal about the expected slowdown in the US economy, which traders fear most, the FT wrote.
Forecast for rate growth for 2019. At the same time, investors clearly hoped that the Fed would reconsider its plans to raise rates for next year. Against the backdrop of falling oil prices, economic slowdown in China and the EU, as well as expectations that the effect of Trump’s tax reform will fade away, the Fed is unlikely to be able to raise rates more than twice next year, Reuters wrote yesterday. Later at a press conference, Powell confirmed these expectations - despite the fact that a third of FOMC members still expected three rate hikes next year, Powell said that the regulator was likely to raise it only twice . But this was not enough for investors.

Market reaction. After Powell's speech, the S&P 500 index lost almost 3% in an hour, later recouping about half of the decline, about two-thirds of the securities included in the Stoxx Europe 600 index also fell in price, and the price of WTI oil fell below $48 per barrel at trading in New York. The stock market's reaction to the Fed's announcement turned out to be the worst compared to all other statements by the regulator since 2011, writes Bloomberg: analysts surveyed by the agency say that investors considered the Fed's decision to be wrong.

Reasons for the fall. Investors expected the Fed to raise rates this time, but were not prepared for the fact that the regulator was going to continue doing so next year - despite the prevailing volatility in the market and fears about the slowdown in the global economy. “The U.S. economy is still strong, but forecasts are for a slowdown, as well as a slowdown for the broader global economy,” said Brendan McKeana, strategist at Wells Fargo. “Investors believe the Fed misjudged the situation,” Kyle Rodda, an analyst at IG Group, told Bloomberg. “We are probably entering a stage where markets are getting used to the idea that they need to prepare for a protracted decline next year.”
Powell's speech. At a press conference after the announcement of the Fed's decision, the head of the regulator, Jerome Powell, tried to send a signal to the market that further tightening of monetary policy may not follow. In particular, he noted that the key rate has already reached the lower limit of the neutral level range, and significant uncertainty remains about a further rate increase. Powell several times called the economic growth forecast for next year “positive” and the US economy very healthy. But at the same time, the Fed announced that it had worsened its GDP growth forecast: to 3% instead of 3.1% in 2018 (this is still the best figure since the crisis year of 2008) and 2.3% instead of 2.5% in 2019.

How the Fed's decision will affect Russia

Rate increase may lead to further weakening of the ruble and spur the exit of investors from Russian assets, says Oleg Shibanov, associate professor of finance at NES. Investors, seeing rising rates, and knowing that the Fed will not raise them for some time, will move into American assets. But sales in the market will be small, because investors have exited Russian assets before, the expert believes.
The outflow will become more intense than all other things being equal, notes Anton Tabakh, managing director for macroeconomics at Expert RA. And in the long term, tightening Fed policy will require Central Bank more intensive rate hike to prevent capital outflow, he believes.

Liana Faizova

Since the end of 2015, the US Federal Reserve has begun normalizing monetary policy. The essence of this process is to bring the level of the effective federal funds rate to a sustainable level in the long term (currently estimated at about 4%), as well as to remove from its balance sheet the excess assets that the regulator acquired as a result of the quantitative easing program.

In December 2015, the rate was increased for the first time in 11 years by 0.25 percentage points. from near zero level. The next time the interest rate increased occurred only a year later - in December 2016, with a shift to the level of 0.5-0.75%. This year, the process of normalizing rates has accelerated, and two increases have already occurred - both of 25 basis points, and following the results of the December meeting, which will end on December 13, the interest rate is highly likely to be increased for the third time.

Why does the Fed raise rates?

Fed officials continue to argue that the rate hike is linked to expectations that inflation will rebound in the United States as the economy grows. Now the regulator is pursuing a policy to protect against a possible surge in inflation in the coming months due to the introduction of tax reform, which involves a significant reduction in the tax burden on business.

Tax reform in the United States is a key driver of high “risk appetite” in global stock markets: its implementation will accelerate US GDP growth next year to 2.0%-2.4% and accelerate inflation dynamics. In addition, the impact of Donald Trump’s presidential program on the economy in 2018, if it extends over 2-3 years, is estimated at 0.6%-0.8% of GDP, since part of the stimulus will most likely be used to repay debts and leveling out the slowdown in current growth rates. Against this background, the Federal Reserve is in a hurry to raise interest rates in order to create a basis for easing business conditions in the event of the loss of growth momentum and the US economy moving towards recession.

In February 2018, the post of head of the Fed will pass from Janet Yellen to Jerome Powell, but this will not change the direction of monetary policy in the United States. Despite the fact that the new head of the Federal Reserve is characterized by softer views, the market expects at least two more rate hikes in 2018 to 2%.

Thus, by the end of next year, the economy and financial markets may fall into an unpleasant trap: interest rates are rising, the Fed is determined to prevent inflation from rising above its 2% target within a year, while the US economy is not seeing much effect from tax reform and, according to forecasts, the rate of GDP growth begins to gradually slow down to 2% - this level can be reached in the fourth quarter of 2018.

What should an investor do?

What are the dangers of raising the federal funds rate to 2%? The fact is that, provided that long-term inflation expectations remain at about 2%, an increase in interest rates has the greatest impact primarily on the short part of the curve, pushing LIBOR rates and Treasury yields with a maturity of up to two years higher. . As a result, by 2019, “short” rates may be higher than “long” ones, which will negatively affect the dynamics of the financial sector. This inversion of the curve is often called a harbinger of recession.

This situation may be exacerbated by a liquidity shortage in the banking system due to the fact that the Federal Reserve, in parallel with raising rates, has begun to reduce its balance sheet. From October, the volume of assets under management of the regulator will be reduced by $10 billion per month, while sales are expected to increase quarterly with the goal of reaching $50 billion per month.

At the same time, an increase in the US government budget deficit in connection with tax reform may have a positive impact on the state of the stock market, fueled by both a decrease in multipliers and the likely announcement of plans by the largest corporations to conduct a buyback and pay increased dividends.

However, the expansion of the budget deficit creates medium-term threats to the Treasury bond market due to the high dependence of the US budget on market attractions of government debt and capital inflows. So in the future, the US Treasury may face an increase in borrowing rates and an increase in the cost of servicing debt obligations.

Given the reluctance of the European Central Bank to rush to raise the key rate, as well as taking into account expectations for the US economy, the euro-dollar pair may fall to the range of 1.14-1.16 per dollar by the end of the year. However, by the middle of next year, the euro may well strengthen to 1.20-1.25 per dollar - economic processes are unlikely to allow the ECB to delay normalizing rates, and fiscal stimulus in the United States will be extended over time, which will significantly smooth out its impact on the American economy , which is in a mature growth phase.

Overall, the start of next year looks quite rosy for the stock and bond markets of both developed and developing countries. Risk appetite will be maintained at a high level, which will push stock indices to new highs, and inflows into high-yield assets can be converted into strengthening currencies of developing countries. The Federal Reserve's further monetary policy, which carries risks of curve inversion, may rather become a good reason for taking profits on risky assets in the second half of next year.

On Wednesday, December 19, the US Federal Reserve System (FRS) will make a decision on the base interest rate for the last time this year. According to analysts surveyed by Forbes, the Federal Reserve will raise rates, as the market expects, despite a noticeable drawdown in the American stock market.

Based on the values of futures for fed funds rates, it is highly likely that the rate will increase at the December meeting, explains investment strategist at BCS Premier Alexander Bakhtin.

The market has set a scenario for an increase in the rate by 25 basis points to 2.25-2.5% per annum, and all current macroeconomic data from the United States indicate that the Fed will not take another pause in tightening monetary policy, says leading strategist at Aton Andrey Kaminsky.

In November, US unemployment remained at 3.7%, the lowest level in almost 50 years, and inflation was 2.2% in annual terms - even higher than the Fed's target of 2%.

Even the emerging correction in the American stock market will not stop the Federal Reserve. Since December 13, all major US indices have shown strong declines: the S&P 500 fell by 4%, the Nasdaq by 4.7%, and the Dow Jones 30 by 4%.

Since the American regulator, when making a decision on the rate, relies on the dynamics of macroeconomic indicators, it has no reason yet to change course due to a fall in quotes, Igor Klyushnev, head of the trading operations department of Freedom Finance Investment Company, is sure.

What will happen to the market and the dollar?

The rate increase is an expected decision, and current securities quotes have already reflected its impact, says Klyushnev. “The decline in indices may temporarily intensify after the publication of the Fed decision, but it will not last long,” says the financier.

For investors, the statements made by Federal Reserve Chairman Jerome Powell will be more important. Analysts expect the rhetoric to soften and hints at a slowdown in rate increases.

The receipt of such signals will have a positive impact on the American market and may lead to an increase in quotes, but at the same time weaken the dollar exchange rate against major world currencies, Klyushnev notes.

If the Fed tightens its rhetoric - and such a scenario cannot be ruled out - the market will face a difficult time. “The United States has set a course for strengthening the dollar, attracting capital from developing countries and increasing the yields of its debt securities, so a gradual increase in rates is what is needed to achieve both economic and political goals,” says Alor Broker analyst Alexey Antonov.

In his opinion, after the rate increase, the S&P 500 index will continue to decline to a level of 2,400 points, the euro-dollar pair will tend to 1.1 over the six-month horizon, and towards parity over the next year, if the current Fed policy is maintained.

Impact on Russia

If the Fed's rhetoric softens, the positive sentiment of American investors will gradually spread to other capital markets, including the Russian stock market, says Anton Kostin, asset manager at Sistema Capital.

The Fed's policy may ultimately affect the ruble exchange rate and the yield of Russian securities. “The rise in rates in the United States is forcing the Russian Ministry of Finance to raise the OFZ yield in order to restore the narrowing gap between the yield of bonds in dollars and in rubles. A decrease in the difference between ruble and dollar yields would be a signal for foreign investors to sell OFZs, and this would lead to a sharp weakening of the ruble,” explains Igor Klyushnev.

According to the analyst, the Fed’s decision will not in any way affect future decisions on the Central Bank’s key rate. “On December 14, the Bank of Russia raised the rate in advance, even before the Federal Reserve meeting, so as not to provoke an outflow of investors from the OFZ, since it is known that the Federal Reserve is highly likely to raise the base interest rate. However, after the Fed meeting, actions to change the key rate will not be required,” explains Klyushnev.

However, if the Fed rate hike cycle continues, the dollar will strengthen, and the ruble exchange rate will see a noticeable decline. According to Alexey Antonov, the dollar to ruble exchange rate will exceed the 70 ruble mark even before the new year, and after the Christmas holidays the fall of the ruble may intensify.

"Wooden" can strengthen

The US Federal Reserve raised the base rate by 0.25% to 2-2.5% per annum. This year, the Fed has planned another hike to 2.375%. Since the beginning of the week, markets have been waiting for this decision in order to understand what the monetary policy of the American regulator will be. When clarity has arrived, we can expect a strengthening of the dollar and, as a result, a weakening of the ruble. MK experts gave a forecast of the exchange rate.

Leading analyst at TeleTrade Group Mark Goikhman: Before the Fed's decision, the ruble exchange rate stopped in equilibrium. Since the Federal Reserve meeting is the main event of the week, the rate increase from 2% to 2.25% was predictable and long ago included in prices. For the ruble, an increase in the Fed rate itself would be negative, since it makes the dollar more attractive to investors and reduces the demand for risky assets, which includes the ruble. However, if the Federal Reserve’s insufficiently confident tone leads not to growth, but to a decline in the dollar on the world market, the ruble may respond with growth. The movement of the ruble can go both up and down, depending on the nuances. In the coming days, the possible range of the ruble to dollar exchange rate of 64.5-67.5 rubles should be considered relevant.”

Roman Blinov, head of the analytical department of the International Financial Center: “As the entire financial world expected, the US Federal Reserve has once again raised the level of the base discount rate, which will affect the exchange rate of the American currency and, naturally, all other currencies of the world, including , ruble We believe that at the moment the ruble, being under the pressure of external factors, still has a chance of another round of decline to levels of 68 - 69 rubles per US dollar and to a level of 79.0 - 80.0 per euro. The reasons for this are quite banal - the desire of global investors to buy US dollars on the global foreign exchange market and new possible sanctions against Russia. Although the topic of sanctions is extremely hackneyed, it probably shouldn’t be discounted. Nevertheless, while the ruble has a chance to strengthen, everything in this world is changing extremely quickly. Oil, of course, provides great assistance to the Russian Federation, but the global surge in global financial turbulence may not be in favor of the ruble.”

Federal Reserve System, USA: online meeting calendar and current interest rate information. The last meeting took place on July 31, 2019, the current interest rate is 2.25%.

Federal Reserve - interest rate chart

The Federal Reserve System in 2018 is an important link in the American and global economic system. Understanding how the Fed works, what processes it influences and what it regulates in the world gives advantages to any novice investor.

The Federal Reserve is the regulator of the US banking system. But, unlike the rest of the world's central banks, in America the central bank is a private structure that was formed at the dawn of the country's independence in 1813, when several national banks of the colonial countries operated on its territory. They did not have enough information to take into account local specifics, and therefore national banks worked ineffectively, especially during periods of crisis.

Federal Reserve Headquarters in Washington

Fed rate

The principle of issuing dollars into the US economy is as follows: in fact, the state borrows dollars from the Fed by selling it its government debt bonds, which are repaid later with interest. The amount of this interest is the Federal Reserve's federal funds rate.

Since, according to state requirements, banks must always have a certain reserve of funds, the need for loans arises constantly. By adjusting the rate, you can increase or decrease the balance of funds in commercial bank accounts. Loans are provided only for excess funds, i.e. by an amount greater than the required reserve established by the regulator.

The Fed cannot accurately set or determine the refinancing rate in the interbank market. Only the size of the discount rate is determined precisely. The refinancing rate is achieved through open market trading. Therefore, its level is set in a certain range in increments of 0.25% and is called the target rate.

The refinancing rate is key because... affects the size of the loan for ordinary consumers - individuals and legal entities. Banks are not required to use target rates, but use them as a guide. In order to keep the rate within the specified limits, the regulator itself actively trades on the market. The average of bank rates is called the effective federal funds rate.

Fed meetings are held according to the annual schedule. Decisions are made there on the country's monetary policy. These decisions are important for the entire global economy, because The dollar remains the world's main reserve currency.

The meetings end with a press conference by the chairman of the board, where he announces the results of the meeting and answers questions from the press. Results are always posted at 2 pm New York time.

Fed rate hike

2007 was a difficult year for the American economy. In order to ease the burden of the global crisis, the Federal Reserve came to the aid of the financial system by lowering interest rates in the United States to zero. However, keeping rates at a minimum level for a long time is fraught with an increase in inflation, so since 2016 the Fed has entered a cycle of increasing the federal funds rate (“tightening” or “normalizing” monetary policy).

The central bank has been open about its intentions to raise rates, but remains tight-lipped about the timing. Expectations of a rate hike lead to a strengthening of the US dollar, and if they are not justified at the next meeting, disappointed investors sell the US currency on the market.

Structure of the US central bank

The Fed is not one bank, as it might seem, but a family of several regional central banks located throughout America. There are twelve such branches in total. Despite the fact that systemically important banks are private, they are managed by one structure - the Board of Governors. Nine members of the Council are appointed by the President for a term of 14 years, and their nominations are confirmed by the Senate.

The Fed's managers decide all the important issues of the Central Bank - they set regulatory standards, monitor transactions with currency and securities, and set the size of the federal funds rate (Fed's Fund Rate). The Chairman of the Board of Governors of the Fed is Janet Yellen.

In addition to the regional banks of the Central Bank, there is another body - the US Federal Open Market Committee (FOMC). It performs supervisory functions in the internal markets of the states. The committee has twelve members - presidents of the US Reserve Banks and members of the Board of Governors.

There are also other councils that do not have decision-making powers that provide advisory support to the central bank. The main councils are the Federal Advisory Council, the Consumer Advisory Council and the Thrift Advisory Council.

Since the Fed is a joint stock company, its shares are available for purchase by commercial banks in America (of course, meeting certain criteria). Today the Fed has more than two thousand bank shareholders (this is no more than a third of American banks).

Fed shareholders cannot influence or interfere with the approval and adoption of monetary policy decisions. These kinds of important issues are decided only by the Board of Governors. Despite the independence from the US President in resolving issues, state control over the activities of the Federal Reserve exists.

It is carried out by two bodies:

House of Representatives
Congressional Banking Committee

They organize inspections of Federal Reserve banks, analyze reports, and issue recommendations. No one can change the Fed’s decision or impose a veto on it. The president of the country can theoretically fire any employee, but in practice there have been no such cases.

Federal Reserve System - functions

Money issue- printing and putting US dollars into circulation. For the most part, the issued funds are used to purchase US Treasury bonds, after which the dollars enter circulation.
Issue of regulations and laws regulating the operation of the banking system. The Central Bank issues operating licenses to banks.
The Federal Reserve regulates the rights and responsibilities of depositors and borrowers, is responsible for the value of interest rates.
The Fed is monitoring liquidity in the system, if necessary, issues loans on the interbank market, and stores reserves allocated by banks on deposits.
The Federal Reserve regulates interbank payments.
The Fed ensures economic stability, which contributes to its growth and helps strengthen the US economic influence in the world.

US Federal Reserve dollars

To maintain stable economic growth, the Fed buys and sells government securities, sets mandatory standards for banks' reserves of non-performing loans, and sets the size of the base and discount refinancing rates.