All eyes are on the Federal Reserve this week as the Federal Open Market Committee (FOMC) – the body responsible for setting interest rates – meets for the last time this year.
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An increase in the Fed’s benchmark rate, from near zero, would be the first since June 29, 2006. And since the Fed usually needs to cut rates by 4 or 5 percentage points to fight a recession, simple math tells us there’s a good chance interest rates will end up at zero whenever that is.
Why is the fed funds rate important?
Some traders say a rate hike is already priced into gold, and any indications from the Fed that further rate hikes would be slow and gradual could send the metal higher after the Fed meeting.
“Given the strength of the signals that have been sent it would be credibility-destroying not to carry through with the rate increase”, economist and former US Treasury secretary Larry Summers wrote in a blog post on Tuesday. Richard Trumka, president of the US’s largest union federation, AFL-CIO, urged the Fed to “avoid making a mistake by raising interest rates”. Now it would be absurd to say that a 25 basis points increase would tip the economy into recession, but I look at today’s American economy and I say this is not a moment to be hitting the brakes even gently.
The rate hike will separate the Fed from major central banks in Tokyo, Frankfurt, Beijing and elsewhere that are all battling to stimulate their economies and generate growth. Instead, it uses the means available to it as the central bank-creating or removing money from the financial system-to bring about changes that affect the federal funds rate.
Wright says “the potential for normalization of US monetary policy should definitely be seen as a headwind for Chinese attempts to ease monetary conditions”.
But in an interview with the Financial Times, Bank governor Mark Carney appeared to play down the prospect of policy makers at Threadneedle Street following suit on a Fed rate rise.
Keeping rates too low for too long can inflate asset bubbles as investors seek returns that are higher – but riskier – than returns on government debt.
Most will be watching for what Yellen and the FOMC indicate about the pace of economic growth and future rate increases. Fed Chair Janet Yellen has suggested many times that when the data show the economy is strong enough to handle more expensive loans, the Fed will nudge rates up.
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A higher interest rate will make it more hard to get a loan, but will incentivize saving.
