The US Federal Reserve increased the Fed funds rate from 2.25 to 2.5 per cent in December 2018 which was the fourth rate increase in that year and the ninth since the Fed started hiking the rate four years ago. The Fed had also projected two more increases in 2019 to move it up to 3 per cent and stated that further “gradual” hikes would be appropriate.

Even the US Congressional Budget Office, in its 10 year forecast updates released on January 28, expected the Federal Reserve to increase interest rates this year. However, at the end of the two-day meeting of the Fed’s policy-making committee, Fed Chairman Jerome H Powell said, on January 30, the US economic growth has remained “solid “, the central bank expected growth to continue, and the case for raising rates has weakened. This, according to the The New York Times , signals the end of interest rate increases.

The Fed interest rate has remained between two and five per cent over the years except in 1981 when it touched 20 per cent to fight an inflation rate of 12.9 per cent and stagflation . Till September 2008 it was 5.25 per cent. In the wake of the subprime mortgage crisis, the then Federal Reserve Chairman Ben Bernanke had reduced the interest rate to zero in his crusade against the ‘Great Recession’ .

Impact of hike

While the Fed rate hike directly affects short-term interest rates like prime rate, credit card interest rates and saving account rates, it also has its impact on long-term rates like mortgages, corporate bonds and 10-year treasury notes. In his article ‘When Will the Fed Raise Rates?’, Kimberly Amadeo notes that in response to the Fed’s move to raise interest rates forex traders expected the dollar’s value to rise. They shorted the euro that caused the dollar to strengthen by 25 per cent in 2014 and 2015.

Any rise in US interest rates leaves its impact on the global economy, particularly in emerging markets where the effect is much more pronounced. For instance, when the Fed raised the interest rate from 1.75 per cent to 2 per cent in June 2018, currencies in several emerging markets like Brazil, Turkey and Argentina slide significantly. Since any hike in the US interest rate also lures investors back, countries like Indonesia, Hong Kong and Malaysia had to increase their own interest rates.

It is a well known fact that President Trump has been against rate hikes. In December 2018, he had tweeted against rate hikes: “It is incredible that with a very strong dollar and virtually no inflation, the outside world blowing up around us, Paris is burning and China way down, the Fed is considering yet another interest rate increase”. Frustrated by this move, Trump was even heard discussing the possibility of firing the Federal Reserve Chairman though he was advised against any such move. But the decision to defer further hikes in interest rates is not likely to have been influenced by such political factors.

Powell, in his press conference, said trade tensions, Brexit and the recently ended government shutdown had increased the uncertainties in the economy. He also felt that business and consumer sentiments had declined in recent surveys, which made the Fed more cautious.

Greg Mc Bride, chief financial analyst at personal finance website Bankrate.com, has advised consumers to take this announcement with a grain of salt as the Fed could be adopting a wait-and-see approach for the time being.

The author is a former staff member of the IMF.

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