The Fed’s Potential Interest Rate Hike Gets a Calm Reaction

The U.S. Federal Reserve dropped a surprise on markets Wednesday with plans to raise the benchmark interest rate to 0.6% from near zero by late 2023, a year earlier than expected.

After chewing on the news for 24 hours, markets reacted in myriad ways Thursday: gold prices are down, the U.S. dollar is up, but most of all fears of inflation seem to have stabilized and there is an overriding sense of calm.

Inflation Cessation

The Feds most commonly raise interest rates to cool an overheating economy, and the good news is they’re dealing from a position of strength:

• The Fed thinks the U.S. economy will grow by a bustling 7 per cent this year, and 3.3 per cent in 2022. That gives them leverage to put some brakes in place down the road.
• In the meantime, they’re confident that, while inflation is rising, it will stabilize. Core inflation will jump to 3 per cent this year, but fall to 2.1 per cent in 2022 and 2023, which the Fed sees as consistent with economic recovery.

“None of this really impacts what people are going to be doing the next six months,” Lee Baker, a certified financial planner and owner of Apex Financial Services in Atlanta, told CNBC. “For most clients, candidly, it’s not that big a deal,”

Gold Loses Lustre: While regulators see upward pressure on consumer prices as temporary and financial planners mostly shrugged at the news, one group of investors felt shockwaves:

• Goldbugs, those ever bullish commodity investors, saw their precious metal tumble to the tune of 5% Thursday (as the opportunity cost of holding gold increases when rates rise).
• The Fed’s hawkish turn also lifted the U.S. dollar (putting additional pressure on gold because it’s denominated in dollars). The ICE Dollar Index, which measures the currency against six major rivals, was up 0.9% Thursday afternoon and trading at the highest levels in two months.

The Bottom Line: Lisa Hornby, a fixed income head at Schroders told the FT, “We can’t keep living in this world where the Fed has rates at zero and is buying $120 billion securities a month and we have a very strong growth outlook.” And she’s right, $120 billion per month is a lot.