The Federal Reserve Just Signaled That Higher Rates Are on the Horizon

Andrew Cummings
September 22, 2017

USA stock indexes overcame an afternoon wobble to close mostly higher Wednesday after the Federal Reserve said it would start reducing its huge bond portfolio next month and was still on track to raise interest rates later this year.

Central bankers pointed to signs of strength in the USA economy, including a pickup in household spending and growth in business investments, in a statement following the Federal Open Market Committee's two-day meeting.

U.S. Treasury yields rose, the dollar gained after the U.S. Federal Reserve signaled Wednesday it expects one more interest rake hike by the end of the year. But, according to median forecasts from the FOMC members, it still expects an increase in the rate of interest in the day-to-day a quarter of a percentage point in December and three more in 2018, if the economy evolves as expected.

On Wednesday, the Fed left rates unchanged, hovering between 1% and 1.25%.

According to the Fed's economic projections which were released on Wednesday, Fed officials expected the U.S. economy to grow 2.4 per cent this year, higher than their forecast of 2.2 per cent in June. There was also little reaction to the Fed's announcement that it would begin decreasing its balance sheet next month.

The move, which was widely expected, will see the Fed remove $6bn (£4.4bn, €5bn) of US Treasuries and $4bn of mortgage-backed securities from its balance sheet each month from Q4. The Federal Funds Rate, a benchmark rate for overnight bank loans, had been close to zero for years but had risen to 1.0 to 1.25 percent in June.

The decision comes as the USA central bank sees economic activity "rising moderately," with a labor market that "continued to strengthen" creating "solid" job gains since the Fed's last meeting in July.

Bank of Korea Governor Lee Ju-yeol told reporters that the Fed's bond sales will not significantly affect South Korea's financial market given that they were foreseen.

As per official predictions quoted in reports the unemployment level is expected to stay near the four per cent mark for at least the next three years.

Fed Chair Janet Yellen made it clear that the Fed has no plans to tinker with this approach.

But, it can't go too slowly because if/when the economy takes a downturn, the Fed does not want to have a bloated balance sheet that limits its ability to help.

Despite almost seven years of uninterrupted job creation and a very low unemployment rate of 4.3 per cent, inflationary pressures and wage gains have been tepid at best, something that has baffled economists.

In past years, she said the Fed has been able to point to root causes of low inflation: the gap between those employed versus those that aren't, energy prices and a rising dollar.

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