What Next for US Interest Rates?

Charles Purdy, Contributor, Forbes

December 24, 2015

After a nine-year interval between interest rate rises, the U.S. Federal Reserve has finally provided wondering investors with closure, by raising interest rates, albeit modestly, by a quarter of a percentage point, from 0.25% to 0.5%.

The dollar strengthened following the announcement, boosted by the current of confidence inspired by the factors foreshadowing the rise in more recent times, such as falling levels of unemployment and incremental rises in the inflation rate. Given that the rate hike had already been factored into markets, it could have been expected not to have affected the U.S. dollar. However, there was always a possibility that the Federal Reserve might not increase interest rates, although small, plus the decision in the end was unanimous by all its members.

Dovish Interest Rate Outlook From The Fed

The Federal Reserve is playing the slow game, popular with other central banks of late, such as with Mario Draghi’s recent lackluster plans for quantitative easing (QE). Buoyed by the rosy outlook for the US economy since it completed its latest round of QE last October, some investors had wondered how aggressive the Federal Reserve would be once it started increasing interest rates. However, the Federal Reserve has made it clear that the increases will be data dependent, with gradual hikes and no set frequency or amount for the increases.

The biggest surprise of the day came, arguably, from the bond markets, which saw the strengthening of U.S. bonds. Despite the fact that a higher interest rate makes holding government bonds less attractive, they increased in value on the back of the Federal Reserve interest rate announcement.

What Happens Next?

As the year draws to a close, and with no more significant announcements expected from the Federal Reserve until 2016, we would expect a relatively quiet seasonal break for the U.S. dollar, all else being equal. However, given the prominence of the U.S. economy, it (and by association, the dollar) has the ability to be influenced by events elsewhere.

Looking forward to 2016, though, the playing field is wide open when it comes to factors that could influence further Federal Reserve interest rate decisions. These include:

  • Unemployment levels. Labor data has historically been important to Janet Yellen, Chair of the Federal Reserve. It is likely to keep being one of the key drivers over interest rate decisions.
  • Inflation. Although inflation levels have been increasing, most recently hitting 0.5% in November 2015, they are still a long way off from the Federal Reserve’s target of 2%.
  • Consumer debt. Consumer debt – led by mortgages – is still applying pressure on the economy.
  • Economic growth. The U.S. economy is out of a recession and expanding, thanks, in part to the central bank’s QE programs, but it faces competitive risk from wild card China. Given the Chinese yuan’s recent inclusion in the International Monetary Fund (IMF)’s Special Drawing Rights basket, and its move towards a free-floating currency, all bets are off as to what course its economy – and currency could take; it could provide a stiff competitor to the U.S., particularly in the exports arena.

As the year slows to a close, investors can relax in the knowledge that months of speculation and waiting has come to an end: the Federal Reserve has raised interest rates. However, the economic landscape is constantly shifting, so we look forward to 2016 by assessing the risks to further interest rate hikes, which could threaten the economy – and U.S. dollar strength.

This article was written by Charles Purdy from Forbes and was legally licensed through the NewsCred publisher network.

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This article was written by Charles Purdy from Forbes and was legally licensed through the NewsCred publisher network.

Investment and Advisory Products and Services are:

  • Not insured by the Federal Deposit Insurance Corporation (FDIC)
  • Not a deposit or other obligation of, or guaranteed by, any bank
  • Is subject to investment risks, including possible loss of the principle amount invested

The strategies mentioned in this article will often have tax and legal consequences; therefore, it is important to bear in mind that First Republic does not provide tax or legal advice. This information is provided to you “AS IS”, does not constitute legal advice, is governed by our Terms and Conditions of Use, and we are not acting as your attorney. We make no claims, promises or guarantees about the accuracy, completeness, or adequacy of the information contained here.  Client’s tax and legal affairs are their own responsibility – Clients should consult their own attorneys or other tax advisors in order to understand the tax and legal consequences of any strategies mentioned in this article.

The views of the author of this article do not necessarily represent the views of First Republic Investment Management.