US Fed: Impact of Putting off Rate Hike

They should have taken the bull by the horns…

When the US Fed decided to put off a rate hike for the umpteenth time, it hardly came as a surprise. Over the last few quarters, the Fed has been consistently putting off a rate hike due to the highly volatile global market situation. But in reality, the Fed may have actually missed out an opportunity. Let me explain why…

Central bank independence…

The US Fed should have allowed the dictates of data to determine which way the US Fed rate moves. Purely based on data, there was a strong case for a rate hike. GDP was picking up and the US economy was getting pretty close to optimal employment. Inflation may have been an issue but that was always a function of cheap oil and cheap commodity prices.

There is a larger issue of central bank credibility in this case. For too long the Fed has talked about a rate hike and refused to act on the same. Taper can be a good guide. Fed started talking about a US Taper in mid-2013 and by the end of 2013, the Fed was on an aggressive path to wind up its QE program. That really ensured that the credibility of the Fed under Ben Bernanke was maintained. In contrast, the Fed has been really dilly-dallying on the issue of rate hikes for over a year now. A central bank that listens very closely to the voice of the equity and bond markets is not a great idea.
A signal of growth…

More importantly, a rate hike would have been a clear signal that growth was returning to the global economy. Remember, the US is already growing at closer to its long term average rate. Europe is seeing green-shoots of recovery. It is probably China and Japan that are really seeing a slowdown in growth. In the case of China, the economy is still growing at close to 7%, which is commendable for an economy that has an annual GDP of $11 trillion.

The Fed has lost out on an opportunity because even a marginal hike in rates would have given a clear signal that the world economy was growing. That would have been a more valuable signal than all the other financial markets pampering that the Fed has done.

Marking to market…

Janet Yellen has tried to play it safe since over the last 9 years there has been no history of a rate hike. Remember, the last rate hike happened in 2006. Yellen obviously had a few key worries. A rate hike would have strengthened the dollar to the detriment of global US companies. The risk-off trade was already leading to a deluge of inflows into the US. What the US Fed has done in the process is to miss an opportunity. A small rate hike with a clear path and guidance on peak rates would have helped much more! ©

Learn more about Indian share market news and tips at Religare online.

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