One Step Ahead: The Fed Vows to Increase Rates

What?

This week Janet Yellen was giving testimonies in front of the Congress during her official semi-annual meeting. Amid all else, Ms. Yellen opened the doors for possible forthcoming monetary tightening, the first one of its kind for the past 6 years. She cautiously announced a possible rise in rates “possibly in June, or even later this year”. Important fact, considering that since the beginning of the financial crisis, the Fed has been committed to keeping rates as low as possible, hoping to bootstrap the economy. Now, things seem to have changed.

Why?

The American economy finally seems to be getting healthy. Sound GDP growth figures, rallying financial markets, and climbing wages bring hopes that the fenix seems to finally rising from the ashen. And despite the fact that neither inflation, nor growth figures have reached their expected values, the Fed brings its tightening policy plans to the table. The reason is that with monetary policy it is equally important not only to track the events that already took place, but also foresee what might take place. If everything goes according to the Fed’s scenario, then such a preemptive growth of rates could yield its results when the economy really gets running. A gradual increase of rates would, ideally, not only allow to mitigate possible inflation, but also be less shocking for the economy, without causing an abrupt change later on (when the economy is recovering, at one point or another contracting economic policy is needed, otherwise inflation might be inevitable). In such a way the Feds pledges to take one step ahead of inflation, to be two steps in front in the end.

What next?

Some say that the Fed had been irrational unveiling its plans so long before they could actually be implemented. With wage growth well below expectations, and the economy overall well below full employment, it is hardly surprising that the markets in the USA did not seem to be too bothered. Most likely the reason for such indifference is the fact that the rise is, at least for now, too distant and illusory. That said, the echo of this tentative decisions can be heard already now in some other markets that are seriously dependent on the dollar (tumbling currency of Indonesia in the face of a stronger dollar).

 

To wrap everything up, it is difficult to predict what effect such decision will have on the US economy, or the world’s economy as a whole, since it is still too far out. However, it is already clear that with a stronger dollar and weaker euro, the pressure on the American economy as a huge consumer market will be growing, and the world’s mega-exporters such as China and Germany will not miss their opportunity to use that. Will the US manage to pull the stagnating Europe out of the turmoil? Well, as one very familiar to us person says: wait and see.