We have lift-off, but can the Fed normalise?

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.


Keith Wade

Keith Wade

Chief Economist & Strategist

Fed hikes rates

It has probably been the most long awaited quarter of a point rate rise in history, but the US Federal Reserve (Fed) has finally pulled the trigger by increasing the target range for the Fed funds rate by 25 basis points (bps), to 25-50bps.

In the accompanying statement the US central bank noted the further improvement in the labour market and that “underutilisation of labour resources has diminished appreciably”.

Although inflation has yet to return to target, it was expected to rise to 2% as the transitory effects of declines in energy and import prices dissipate.

Taking into account domestic and international factors, they said the “risks to the outlook are balanced”.

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.

These were little changed and show an economy growing at 2.4% next year with unemployment falling further to 4.7% and inflation ending the year at 1.6%.

Policy path

The inflation projection is a tad lower than before and no doubt reflects the move in the dollar and oil prices since September.

The projected policy path is also a little lower with the median Fed funds rate at 1.4% by the end of next year and 2.4% by the end of 2017.

The long run rate is still at 3.5% though, indicating a slow lift-off and then greater tightening further out.

Although these interest rate projections are not meant to be guidance they are read closely by the markets and in this respect were probably a bit less dovish than might have been expected.

There is plenty of evidence (some of which was presented to the Fed back in October) that the long run equilibrium rate in the US should be 2% (zero in real terms) or thereabouts, so they could have cut their long run forecast.

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.

Important information

This communication is marketing material. The views and opinions contained herein are those of the named author(s) on this page, and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds.

This document is intended to be for information purposes only and it is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The material is not intended to provide, and should not be relied on for, accounting, legal or tax advice, or investment recommendations. Information herein is believed to be reliable but Schroder Investment Management Ltd (Schroders) does not warrant its completeness or accuracy.

The data has been sourced by Schroders and should be independently verified before further publication or use. No responsibility can be accepted for error of fact or opinion. This does not exclude or restrict any duty or liability that Schroders has to its customers under the Financial Services and Markets Act 2000 (as amended from time to time) or any other regulatory system. Reliance should not be placed on the views and information in the document when taking individual investment and/or strategic decisions.

Past Performance is not a guide to future performance. The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested.  Exchange rate changes may cause the value of any overseas investments to rise or fall.

Any sectors, securities, regions or countries shown above are for illustrative purposes only and are not to be considered a recommendation to buy or sell.

The forecasts included should not be relied upon, are not guaranteed and are provided only as at the date of issue. Our forecasts are based on our own assumptions which may change. Forecasts and assumptions may be affected by external economic or other factors.

Issued by Schroder Unit Trusts Limited, 31 Gresham Street, London, EC2V 7QA. Registered Number 4191730 England. Authorised and regulated by the Financial Conduct Authority.