The Federal Reserve (Fed) on 15 March decided to increase interest rates for the first time during this year but only three months since the last interest rate increase in December 2016. The base interest rate was increased from 0.75% to 1%.
Despite worries that a higher interest rate would work against consumer spending, the Fed amplified forecasts by economists that it might be planning to proceed with additional rate increases before the end of the year in order to prevent the inflation level from rising above its long-term target of 2%.
The Fed Chairwoman Janet Yellen spoke right after the interest rate decision on Wednesday and according to her, the U.S. economy was strong enough and left no other option for policymakers than to increase interest rates towards levels last seen during the 2008 financial crisis. Mrs Yellen also mentioned that she is anticipating in having a “strong relationship” with newly appointed treasury secretary Steven Mnuchin after their discussions on the economy and objectives set.
The retail sales report released on the same day by the Census Bureau showed a marginal increase during February by 0.1%, and according to the Bureau of Labour the Consumer Prices Index (CPI) for the last twelve months until February increased to 2.7% in comparison to the previous month’s level of 2.5%. The inflation level for February excluding food and energy was at 2.2%.
Markets had widely expected the interest rate increase on Wednesday but what took them by surprise was how the markets reacted. Stock markets and precious metals rose following the interest rate decision while the U.S. dollar fell. The S&P 500 increased by 0.8%, and the NASDAQ and Dow Jones soared by 0.9% and 0.3% respectively. The EUR/USD however jumped by a noteworthy 1.2% to 1.0739 because of the dollar’s loss in momentum and that also caused the price of gold to increase by 1.8% to $1,221.92 per ounce. The yellow metal’s surge continued until the end of last week to a total of 2.4%.
Some investors said that the outcome of the Fed meeting could have been worse. Everyone was anticipating the interest rate increase and given the strength of the employment sector there were some rumours for a 0.5% hike. Janet Yellen signalled on Wednesday that the interest rates might continue to rise but at a modest pace. The Fed expects the economy to grow in such way that would allow for incremental hikes and that is an indication of more increases to come before the end of the year.
Although the Fed increased interest rates only three times since October 2015, it is widely accepted that interest rate “normalisation” is on its way and it is likely to keep the U.S. dollar at strong levels. Moreover, the current gap between the Fed rate and the ones of Eurozone, UK, and Japan provides further evidence that the dollar might receive additional support. This scenario may be hijacked should the U.S. economy fail to continue strengthening but at this moment it is not looking so likely given President Donald Trump’s plans to lower taxes and increase infrastructure spending.