US interest rates set for lift-off

Markets are abuzz with talk of “lift-off” in US interest rates: the first interest-rate increase in America for nearly a decade is looming. When the global financial crisis broke out, the US Federal Reserve cut its benchmark interest rate to 0%-0.25%. Now, with the economy gathering strength, a small increase in the cost of money, to ensure that inflation doesn’t get out of control, looks like a sensible idea, as Fed boss Janet Yellen has signalled.

Markets have pencilled in the first 0.25% rise for September, and the latest data suggests this is increasingly likely. The unemployment rate held steady at a post-crisis low of 5.3% and 215,000 jobs were created. Payrolls have grown by over 11 million since the Great Recession ended, says Barry Ritholtz on Inflation is subdued for now, but “we are seeing early signs” of wage growth, a key source of inflation, strengthening. Job openings are on the rise and companies are finding it increasingly difficult to replace workers.

Moreover, remember the bigger picture, says Ritholtz. Having interest rates at practically zero “is an emergency setting”. The recovery is six years old and gathering steam. “Why do we still have a Fed policy designed for an economy that needed life support?” Higher rates are simply a move back to normality. Expect that move to be very slow, however. Zero interest rates and quantitative easing (QE), or money printing, have blown up bubbles in asset markets, and little of the developed world’s debt has been paid off in the past few years.

So a sudden rise in interest rates could cause serious turbulence in markets and indebted economies. If there is another crisis, however, the Fed will be completely stuck if interest rates are still historically low, especially as the jury is still out as to what impact QE has actually had on economic growth. So another reason to raise rates is to “put some bullets back in the exhausted gun of ordinary monetary policy”, as’s Tyler Durden puts it.

In the short term, however, there are two reasons to anticipate a very gradual upward trajectory for interest rates, says John Authers in the Financial Times. A rate hike would further boost the US dollar, keeping a lid on inflation. The dollar has risen by almost 40% since 2008 on a trade-weighted basis (against a basket of trading partners’ currencies).

And any further decline in oil, moreover, would point to less investment by American shale producers, which has bolstered overall growth in recent years. So it could be quite a while before rates rise for a second time, concludes Authers. Not so much lift-off, then, says Deutsche Bank, as “crawl-off”.

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