March 17, 2016    3 minute read

Federal Reserve Rate Hike: To Be or Not to Be?

   March 17, 2016    3 minute read

Federal Reserve Rate Hike: To Be or Not to Be?

It has been approximately eight years since the Federal Reserve kept the interest rate near 0% and ten years since it has decided to raise its interest rate. Since the Federal Open Market Committee Meeting in June 2015, market’s expectation of the fact that whether the Federal Reserve would raise its interest rate has been highly speculative. The market sees an overwhelming 88% probability rate hike before or in December with an extent of 2-4 times; while data collected in February 2016 reflected that only 20% of respondents believe that the Federal Reserve will raise its interest rate in 2016. The latest research has found that the market estimates a 36% probability if raising the interest rate in 2016 with the magnitude of 1-2 times. Some even estimate the rise will occur in March.

In light of the fact that key leading economic indicators reflecting the aggregate demand of the US such as durable goods orders and the ISM manufacturing index have shown a substantial decrease, economists and analysts have doubted the ability and determination of the Federal Reserve in raising the interest rate, at the same time leading to suspicion that the US might be heading towards the phase of recession. Janet Yellen, Chair of the Board of Governors of the Federal Reserve System, has stated clearly in the United States Congressional hearing during early February this year that the interest rate hike would less be likely to occur in March due to uncertain global economic conditions, yet there is still possibility regarding the rise in interest rate in the last quarter of 2016.

With the downward pressure on the global economy, continuous increase in labor costs, as well as high volatility in global capital markets, it is a hard decision to make under the environment with normalisation of monetary conditions. If the Federal Reserve delays its monetary policy, this might be good news to new emerging markets regarding economic activities and net capital flow. According to the Institute of International Finance, net capital flows have been recorded as negative in global emerging markets, which is, in fact, the first time since 1988. Hence, the impact of such monetary policy in countries such as Brazil, China, and Russia, which relies heavily on international capital to aid debt financing, would also be delayed or even be diminished.

On the other hand, there has been growing fears within the industry regarding the impact of higher interest rate on the Renminbi market. The significant outflow of capital has been recorded since the Chinese government’s devaluation of the yuan in August 2015. Assuming higher interest rates being effective, analysts fear that there might be greater sums of capital flowing out of China into US dollar market. Thus, a delay or an estimated gradual hike of the Fed interest rate would undoubtedly be a relief to emerging markets and the yuan currency market.

The ultimate question–when would the Federal Reserve raise its interest rate, remains unanswered. If the economic downturn imposes huge pressure on US economy and banking sector, there might even be a possibility for the Federal Reserve to implement negative interest rate policy. Yet, it seems that all conjectures will remain unjustified until further information of the timeline is being disclosed.

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