The US Federal Reserve has increased its key interest rate for the first time in nine years, in a move welcomed by the stock markets.
The Fed increased its benchmark interest rate to between 0.25% and 0.5%, from the previous interest rate range of 0%-0.25%.
This rate increase was widely expected by analysts and global investment markets have responded positively to the news, with European stock markets up by 1-3% in morning trading.
An interest rate rise in the US was prompted by “considerable improvement” to the jobs market and was described by Fed chairman Janet Yellen as a “gradual” process to move interest rates back towards normal levels.
Commenting on the rate rise, Stephanie Sutton, Investment Director – US Equities at Fidelity International, said:
“Investment commentators had been earnestly debating the likely timing of the first US policy rate hike from virtually zero for several years now.
“However, each time an increase appeared imminent, expectations had been dashed owing to either weak economic data or events, such as the recent China-related market volatility.
“This time around economic data and global conditions were supportive enough to allow the Fed to initiate its first interest rate hike in almost a decade.
“With the first rate hike now behind the market, the focus will turn to the pace of further rate hikes. Whilst gradual rate increases have been priced in, any acceleration in the pace might create uncertainty and volatility.
“Further, whilst the hike in itself acknowledges the good health of the US economy, it certainly increases the debt burden on both households and companies.
“Thankfully, there is little risk of payment shocks or greater defaults post lift-off as the bulk of household and non-financial corporate debt is in fixed rate loans.”
Also commenting on the rate rise was Ian Kernohan, Economist at Royal London Asset Management, who said:
“The first Fed Funds hike since 2006, the first in a cycle since 2004 and the first that many finance professionals will have seen in their career, has finally arrived.
“The journey from rate cuts, through quantitative easing and tapering, to this latest development has been a long one with the current economic cycle already quite mature.
“The debate now moves on to the likely speed of hikes during 2016, with the market expecting a very gradual pace. Some voices argue that this increase is a policy error and will soon have to be reversed.”
Another comment came from Keith Wade, Chief Economist & Strategist at Schroders, who said:
“As anticipated the Fed raised interest rates for the first time in nearly a decade, but the risk lies in the market’s expectations of a “slow and low” rate hiking cycle.
“The immediate move has been well telegraphed and so should not come as a surprise to markets; the question now is where are interest rates headed?
“The statement said future moves would be data dependent and that “economic conditions will only warrant gradual increases in the Fed funds rate”. This is consistent with past statements, but puts the spotlight on the Fed’s updated forecasts which accompanied the statement.
“The Fed and Chair Janet Yellen remain committed to a gradual tightening, but the danger is that if they are perceived as being more hawkish than the very low expectations built into markets, then the US dollar will strengthen and push down inflation further.
“In this way the normalisation of interest rates could stall as the currency markets tighten policy for the Fed.”
So comments on this rate rise from the Fed seem to focus on what happens next, rather than what has just happened.
It seems expected that a gradually tightened monetary policy should support rising equity markets in 2016, with history telling us that global equity markets tend to perform well for at least a year after the Fed starts a cycle of rising interest rates.
It will be very interesting to see how markets react to the next Fed rate rise, and whether they are quite as accommodating should interest rates start rising at a faster than expected rate.
Eyes will also be on the Bank of England Monetary Policy Committee, who face a very different economic outlook here in the UK which suggests rates here will at least stay lower for longer.
