What will happen to the market and the dollar if the Fed raises rates. The power of the dollar

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.

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.

On July 26, 2016, a two-day meeting of the Federal Reserve System (FRS) began in the United States, but the Open Market Committee of the American financial regulator will announce its decision on interest rates on Wednesday, July 27, at 21:00 Moscow time. The Fed's decision may have an impact on the dynamics of exchange rates and the activities of regulators in other countries.

Read about how interest rates work and why their changes worry markets.

What is the Fed

The US Federal Reserve System, created in 1913, serves as the country's central bank.
Its main tasks are the implementation of monetary policy by influencing the terms of money circulation and the loan rate, monitoring and regulating the activities of banks, maintaining the stability of the financial system.
To solve these problems, the Fed uses so-called open market operations (purchasing government securities, requiring banks to reserve deposits with the Fed, and setting refinancing rates (base) and discount rates).

What are the rates?

Discount rate, set by regulator directly, determines the cost of loans to commercial banks that the Federal Reserve issues.

Wherein refinancing rate (federal funds rate), which is key, regulated through open market operations. That is, we are talking about the interest on the loan that US banks use when lending their excess funds to other commercial banks experiencing a shortage of reserves. The rate is key because it affects the amount of the loan for the end consumer: individuals and legal entities.
The Fed cannot directly set this rate.
The regulator sets the so-called target federal funds rate, which is a value or range of values. But banks are not obliged to issue funds to other credit institutions at exactly this percentage.
If the regulator notices that banks are using rates that differ from the target, it resorts to buying or selling government bonds to bring the values back into the specified range or to the specified value.
The weighted average of bank rates is called effective the federal funds rate.

Why regulate rates and what does it affect?

When the Fed wants to lower the key rate, it buys government bonds on the open market: this leads to an influx of funds into the market, makes credit “cheaper” and stimulates investment. That is, reducing the rate contributes to economic growth, creates jobs and, therefore, is used to prevent crisis phenomena.
However, excess cash can lead to inflation, and to avoid this, the Fed can raise rates by selling government bonds and artificially creating a shortage of cash in the market.
It is worth noting that regulating markets while balancing economic growth and low inflation is not easy. Low interest rates can lead to bubbles in financial markets and are disadvantageous for many economic participants. At the same time, given high rates, there is a risk of slowing economic growth, and they are especially inappropriate during a crisis.

Why are the decisions of the American regulator so awaited by world markets?

Since the United States is the largest economy in the world, its main indicators and the Fed's measures to adjust them have a strong impact on world exchanges and the currencies of other countries.
Thus, if the rate increases in the short term, the currencies of developing countries may “suffer” as investors abandon investments in them in favor of more reliable US government bonds and deposits in American banks, which raise the rate following the Fed.
At the same time, the dollar is becoming more expensive.

How does the Fed rate affect the Russian economy?

The Fed's rate hike puts pressure on emerging market currencies, including the Russian ruble.
The expectation of a rate increase and, accordingly, a strengthening of the dollar did not allow the ruble to strengthen in May, despite rising oil prices.

Interesting facts about the American regulator

The Fed unites 12 regional banks (these banks are located in major cities - Boston, New York, Philadelphia, Cleveland, Richmond, Atlanta, Chicago, St. Louis, Minneapolis, Kansas City, Dallas and San Francisco).
However, although the Fed is a wholly private company by capital structure, it has a significant government role in its management and is generally an independent federal agency of the US government.
Independence in operation is ensured by the fact that decisions made on monetary policy do not have to be approved by the President of the United States or any of the executive or legislative branches of government.
The Fed does not receive funding from Congress. At the same time, the Fed is controlled by him.
In 1982, an appeals court heard a precedent-setting case in which a private citizen sought compensation from one of the Federal Reserve Banks for losses caused to him by the government. The court's verdict was: "The Federal Reserve Banks are not government entities, but are independent, privately owned and locally controlled corporations. The Federal Reserve Banks were created to perform a number of government functions."

Fed rate dynamics

In the 1950-1960s. The effective US federal funds rate ranged from 0.5% to 9%. In 1973, the oil crisis led to an increase in inflation rates in the country, due to which the target rate was sharply raised from 5.75% to 10.5-10.75%. After declining to a level of 4-7% in the mid-1970s. the rate set records due to a new surge in inflation in 1980-1981. (18-20%). Throughout the 1980-1990s. the rate gradually decreased to around 5%. In 2001-2003, after George W. Bush took office as US President, the rate was gradually lowered to 1% (set on June 25, 2003) to combat the recession. The target remained unchanged for a year, then was raised again. In 2006, new Fed Chairman Ben Bernanke repeatedly raised the rate (up to 5.25% on June 29, 2006) to counter the growth of the housing bubble. However, the onset of the global financial crisis forced the regulator in 2007-2008. reduce the rate. On December 16, 2008, a record low range was set - from 0 to 0.25%, while Ben Bernanke pursued a policy of quantitative easing (in total, the Fed bought assets worth about $4.5 trillion). Since then, the target rate has not changed for seven years, and the effective rate has ranged from 0.07% (December 2012, early 2014) to 0.2-0.22% (February 2009, spring 2010 .). In August 2008, the effective rate was 0.14%. In December 2015, the US unemployment rate was 5%, the lowest since February 2008, and GDP growth was forecast at 2.8%. In this regard, on December 16, 2015, the Fed changed the rate for the first time since 2008, raising it to 0.25-0.5%. As of July 2016, the effective rate is 0.4%.

The American regulator raised the rate by 0.25 percentage points, to 2.25% per annum. And he promised to continue similar actions in the next few quarters.

The Federal Reserve has already raised rates three times in 2018. Before the September meeting, it increased in March and June. Judging by the so-called median dot plot forecasts published by the Fed, 12 of the 16 members of the Open Market Committee (which makes rate decisions) expect a fourth rate hike this year. Obviously this will happen in December. Forecasts for 2019 include three more rate hikes.

The US President has twice in recent days publicly expressed dissatisfaction with the Federal Reserve's policies. However, during a press conference on Wednesday, he even found a positive in this: he interpreted the rate increase as a sign that “the American economy is doing well.”

Careless Fed

Indeed, the American economy is growing rapidly. Last week, the US Department of Commerce confirmed its estimate of GDP dynamics in the second quarter of 2018 at 4.2% on an annualized basis. The country has low unemployment, and inflation reached 2.7% year-on-year in August. Under these conditions, almost 100% of experts predicted a Fed rate increase in September.

However, some of them are sounding the alarm. For example, IC expert Andrei Khokhrin advises preparing for a deep correction in the overheated stock markets of the United States and Western Europe - in severe overheating. “When the Fed began the cycle of rate hikes, there was skepticism that a rate increase would cripple the stock market,” he notes in his report. “The skepticism was not justified. But the Fed is gradually becoming more careless in its actions, less susceptible to market concerns. And, This means that the risks are growing. And the risks of a fall in the States are pressure on Russian stocks and on long-term bonds too.” According to Andrei Khokhrin, the national debts of the United States and Europeans are so large and threatening that in the future it is inevitable that the printing press will be turned on at full capacity in order to pay off uncontrollable debts. “No matter how surprising it may seem now, galloping inflation of the main reserve currencies is a very likely scenario for the development of financial events over the next year or two,” the expert predicts.

“As long as there is economic growth, the interest rate will be raised every quarter,” said the bank’s chief analyst, Viktor Veselov. “This will lead to increased capital outflow from emerging markets, but the central banks of these countries will begin to raise rates.” The process of raising rates in developing countries is already in full swing and does not bode well for the economies of these countries. At the end of August, Argentina raised the key rate from 45 to 60% per annum, in September - Turkey (from 17.75 to 24% per annum), Russia (from 7.25 to 7.5%) and Indonesia (from 5.5 to 5 .75%).

In October, Mexico and India may pick up this trend.

Not scary yet

The yield on 10-year US Treasury bills settled above 3%. On Tuesday last week it rose to a 4-month high - 3.113% per annum. Sooner or later this must affect investor behavior. At the first signs of an approaching crisis, many of them will prefer more conservative and already quite profitable dollar government securities. Which will lead to sales in stock markets, especially in developing countries.

However, according to Sergei Suverov, senior analyst, this will not happen in the next 2 years. Yields on the American debt market will continue to rise, because due to trade duties on cheap Chinese goods, inflation in the United States is increasing, and the Fed will respond to this by raising rates. It makes no sense for investors to buy debt securities when their yields are rising, because the price is falling at that time.

The moment when the Fed rate exceeds inflation may turn out to be psychologically important, that is, the so-called real rate becomes positive. For some investors, this traditionally serves as a signal to sell commodity futures. Following the raw materials themselves, prices for shares of commodity companies may slide down, which can provoke sales in all markets of risky assets.

“Despite the Fed rate increase, inflation in the US is still ahead of it - by about 3%,” states Sergei Suverov. “This suggests that money in America still remains cheap.”

Konstantin Artemov, portfolio manager at Management Company, expects the transition to a neutral Fed interest rate to be completed by the end of 2019. “At the same time, the discount rate will be in the range of 2.75–3% per annum, and inflation will most likely slow down, approaching 2%, despite fairly high energy prices,” he clarifies.

According to Artemov, the growing American economy makes it possible to raise interest rates quite painlessly and unnoticed by the economy. Significant growth in revenue and profit (in dollars) offset the potential decline in profitability.

Natalya Milchakova, deputy director of the company's analytical department, does not believe at all that the Fed rate hike cycle will drag on for a long time.

“I believe that the real base rate in the US will not become positive (exceed inflation) soon,” she says. “After all, the three increases in the base rate in the US this year were precisely aimed at preventing inflation from accelerating. In my opinion , at the level of the base rate in the United States of 2.5%, further increases will stop or at least be temporarily postponed by the Fed, since the goal will be achieved. And the Fed’s goal is twofold - not to accelerate inflation and at the same time not to slow down economic growth. Therefore, a rate increase is necessary. there will be a limit. I don’t even rule out that there won’t be a fourth rate hike in the US this year.”

For your information

Ruble on a wave of optimism

> The exchange rate of the Russian ruble against the dollar has strengthened by 7% since September 10, when the dollar jumped to 70.6 rubles. On Thursday, September 27, the day after the Fed raised the rate, the dollar in “tomorrow” settlements on the Moscow Exchange ended the day at 65.6255 rubles - the minimum for 1.5 months. Experts interviewed by DP do not expect the dollar to return above 70 rubles this year (see comments).
Three factors add confidence in the future of the ruble: high oil prices, the cessation of regular currency purchases by the Bank of Russia and the easing of concerns about the adoption of tough anti-Russian sanctions in the United States. The head of the Ministry of Economic Development of the Russian Federation, Maxim Oreshkin, told reporters last week that in the current conditions he considers the rate of 64 rubles per dollar to be fundamental and by the end of the year we can expect a movement to this level.
> Timur Nigmatullin, an analyst at Otkritie Broker, gives perhaps the most extreme forecast for the strengthening of the ruble. In his review, he wrote that if sanctions were softened or lifted by the US Senate, the dollar could drop to 55 rubles in November. Such a strengthening, according to Nigmatullin, will be supported by a rise in oil prices to $91 per barrel by November 5 “as part of the speculative reaction of market participants to the imposition of sanctions against Iran.” However, by the end of the year, according to the expert’s forecast, the dollar will still rise to 59.3 rubles.

Exchange rates and stock prices rarely reflect the past; they reflect some investor consensus about the future. A significant strengthening of the dollar against a basket of currencies (DXY index) occurred in 2014 and is a thing of the past. If we talk about central banks, the Fed was one of the first to raise rates, now the cycle of raising rates and reducing the balance sheet (monetary easing) is gradually fading away, at the beginning of this path is the central bank of the eurozone (possibly Japan), so I would not expected an accelerated strengthening of the dollar against other world currencies. We expect that the dollar exchange rate against the ruble at the end of 2018 will be at the level of 63–66 rubles.

On Wednesday, September 26, the US Federal Reserve will make a decision on the interest rate - it will be made public at 21:00 Moscow time. This time we have every reason to believe that the market has already fully priced in two interest rate hikes before the end of the year.

Investors assume that changes in forecasts and official comments from the American regulator will be minimal. However, it is possible that fairly high rates of economic growth, positive dynamics of wages and a tendency towards accelerating inflation will become the basis for a more optimistic base forecast and expectations for rates. In this case, we can count on the US dollar strengthening against emerging market currencies.

In August, the rate of core inflation in the United States amounted to 2.2%, exceeding the target level set by the Federal Reserve for 2018 - 2%. At the same time, the unemployment rate at the end of last month was 3.9%, that is, it was even below the target (4%), and the Fed interest rate is still 100 basis points less than the neutral level.

Most members of the Federal Open Market Committee (FOMC) believe that such a divergence of monetary policy from macroeconomic indicators is illogical, so the federal funds rate should be raised more aggressively to bring it into line with the neutral range. Almost all market participants expect an increase in the key rate to be announced today, and expect it to reach approximately 2.5% per annum in December.

In our opinion, the official commentary of the FOMC will not undergo significant changes compared to the previous one, and the political mood of the American regulator will be characterized in it as “accommodative”. We expect the terminal fed funds rate to remain in the 3.25%-3.50% range and the unemployment rate to rise slightly as contractionary policies have some effect. Macroeconomic forecasts are likely to undergo only minimal changes.

In general, the trajectory of the Fed interest rate is unlikely to change, however, we expect that market participants will become convinced that the rate will be increased four times in total at the end of 2018, three times at the end of 2019, and only once in 2020 once.

In the future, the regulator’s possible refusal to use the word “adaptation” when describing monetary policy priorities will be of great importance for investors. The market expects the Federal Reserve's 2018 GDP growth rate to be slightly higher to 2.9%, in line with the second quarter's growth rate (plus 4.2%) and optimistic preliminary estimates for the third quarter.

The unemployment forecast for 2018 will likely be revised to 3.9% (since June this figure has increased by 0.1 percentage points). Some market participants may believe that it would be logical to raise rates again in 2021.

We expect the average dot plot neutral rate to rise slightly to 3%.

At the end of September, the US Federal Reserve raised its benchmark refinancing rate once again this year, raising it to 2-2.25% - the highest level in the last 10 years, since the 2008 financial crisis. Izvestia looked into why every change by the Americans in any direction causes a stir around the world and what a higher interest rate on American loans threatens Russia with.

What does the Fed rate mean?

First of all, you need to understand that the Fed has several different rates in its arsenal. The one that is most often mentioned in the media (the target rate for federal funds, Fed Funds Rate) is not an instrument of direct lending by the American Central Bank. Its essence is that all US banks are required to keep some part of their funds at the Federal Reserve. From the surplus of these funds, they can issue each other ultra-short-term loans lasting no more than a day. It is for this liquidity that the most famous Federal Reserve rate is set. As a rule, it assumes the lowest profitability.

There are other rates that are also important for the financial market, but receive less coverage in the press. Loans to banks directly from the Fed and repo loans are a couple of percentage points above the target fed funds rate. Finally, market rates, such as the percentage charged by banks to their most creditworthy customers (prime rate), are determined independently by financial institutions, but fluctuate quite clearly in time with the base rate.

In this way, the Federal Reserve regulates the entire financial system. When the base rate is low, bankers are more willing to issue loans to the real economy at a lower interest rate, which, on the one hand, stimulates economic activity, and on the other, accelerates inflation. A rate increase, on the contrary, leads to a credit contraction and a slowdown in price growth.

How high is the rate now?

The current increase was the eighth since the end of 2015, which means that the Fed leadership, despite the replacement of Janet Yellen by Jerome Powell, is steadily pursuing a policy of tightening monetary policy. However, before this, for a record seven years in a row, the rate was again at a record low - at the level of 0–0.25%. That is, the Fed handed out money literally for nothing.

This unorthodox policy was caused by the unprecedented depth of the crisis in the States. The Federal Reserve not only lowered the rate to zero, but also adopted large-scale bond buying programs - all in order to keep the economy from collapsing. Although liquidity became virtually free, the economy still developed poorly and weakly, growing at less than 2% per year. For the United States, with its rapid population growth, this is a very mediocre figure.

Since the middle of the decade, improvements in the economy have been noticeable, and since then the Fed has slowly begun to raise rates. Now the situation has almost completely recovered: US GDP growth in the second quarter reached 4.2%, and unemployment fell below 4%. These data may be evidence that the economy is overheated and needs to be somewhat “cooled” with tighter financial policies.

However, the current rate remains low by historical standards. As recently as the turn of 2008, it was 5% per annum, two and a half times higher than now. So there is every reason to assume that it will only continue to increase. Moreover, the Open Market Committee, which decides on the rate, indicated in its statement that the period of “accommodative” monetary policy is over. New York is well aware of the threat of accelerating inflation and overheating of the economy and will do everything to combat these phenomena.

Why is the Fed rate relevant outside the US?

The impact of the Fed's decisions is not limited to America alone. With the US stock market by far the largest and most liquid in the world, the US economy exceeding 20% of the world's, and the dollar remaining the world's leading reserve currency, the effects are felt far and wide.

A high rate means rising yields on US government bonds and other securities. And since the United States has historically been a “safe haven” for investors, when rates rise, they are more actively looking for options for investing in certain assets in America. From which it follows that funds are beginning to be washed away from other markets. The dollar is strengthening, other currencies (all other things being equal) are becoming cheaper. Non-US markets are beginning to experience a lack of liquidity, thereby threatening their economic growth.

Such fluctuations are felt most strongly in countries that supply natural resources. When the dollar goes up, oil usually goes down. And depending on the situation, the price may drop by several percent at once. Following oil, both the national currency and the stock market of the exporting country may collapse.

The current situation in the global economy cannot be called cloudless. Developing countries are experiencing multiple problems, both internal and external. Most of all, investors are worried about the growth of protectionism and the trade war that has begun between the United States and China, which may gradually involve other countries.

In Argentina, whose currency has lost half its value since the beginning of the year, a real crisis has already broken out - the IMF was called in to save the national economy, which is ready to allocate up to $57 billion. So far, this is the largest fund assistance program in history. In Turkey, the picture is similar: the lira is rapidly falling, the country’s bonds have already been transferred to the “junk” category, and inflation has become galloping and is about to jump beyond the 20% mark.

Against the backdrop of all these events, a further Fed rate hike looks especially threatening for emerging markets. In Russia, which is dependent on oil prices, the situation looks scary.

Should we start being afraid?

In fact, at the moment there are no serious threats to the Russian economy - for several reasons. First of all, this time oil prices are reluctant to follow the dollar. Sanctions against Iran and the unwillingness of leading oil powers to increase quotas weaken supply on the market and, accordingly, lead to an increase in the price of “black gold.” In recent days, it has reached another high, exceeding $80 per barrel. At the same time, Russia exports more oil than during previous crises, and its budget depends less on export earnings (since all income above the cut-off price of $40 per barrel goes to the National Welfare Fund anyway).

Secondly, Russia has already experienced several shocks in recent years, starting with the oil collapse in 2014 and ending with numerous sanctions from Europe and the United States. Under these conditions, all investors who wanted to withdraw their money from Russia successfully did so. For the rest, possible troubles, including those associated with raising rates, have already been successfully won back and included in future losses. Therefore, the reaction to the rate increase in the Russian market was sluggish: the ruble slightly slowed down its strengthening, but continued to grow. Moreover, a week ago the Bank of Russia also raised the rate for the first time in a long time, thereby making domestic assets a little more attractive to investors.

At the moment, Russia, which has a good trade balance, a budget surplus and a low level of external debt, including corporate debt, is dangerous not so much from the external environment as from internal indicators. Economic growth remains weak - below 2%, rapid growth in labor productivity is also not in sight, and opportunities for extensive development (which was first driven by natural resources and then agriculture) have largely been exhausted. Without a full breakthrough in economic efficiency, Russia will continue to stagnate, regardless of the actions of local or American financial authorities.