Fed rate hike
Past hikes offer clue on future tightening
The U.S. Federal Reserve has raised its key interest rate for the first time in nearly a decade. The question for financial markets now is how much and how rapidly monetary policy will be tightened over the long term.
Looking at economic conditions -- namely unemployment and inflation -- at the time of the country's three previous rate hikes could help shed light on how things will play out this time around.
The Fed raised the federal funds target rate to 0.25-0.5% from 0-0.25% on Wednesday, ending the zero-interest policy introduced in December 2008 in the wake of the global financial crisis. This move represents the first step toward normalizing rates.
The Fed's mission is to maximize employment and stabilize prices through its monetary policy. The federal funds rate is the interest rate at which private-sector banks take out short-term loans from each other when they need to secure funds to deposit with the Fed. An increase or decrease in the rate affects a wide variety of interest rates, including those for bank deposits, housing loans and corporate borrowing.
The Fed kept interest rates near zero for seven years in hopes that holding down the cost of borrowing for individuals and businesses would shore up the U.S. economy. The country's jobless rate soared to 10% at one point following the financial crisis, but it fell back to the pre-crisis level of 5% in November this year. Among members of the Federal Open Market Committee, the Fed's monetary policymaking body, the median target long-term unemployment rate is 5%. The November data thus set the stage for a tightening of monetary policy.
Comparison of past, present Fed rate hikes
The big question is how fast it will be tightened. The median forecasts of FOMC members put the federal funds rate at 1.375% at the end of 2016, 2.375% at the end of 2017, and 3.250% at the end of 2018.
The actual pace of the rate increase will likely be slower than in any of the three most recent tightening cycles.
In each of those instances, the federal funds rate was above 5% at the end of the cycle. This time, however, FOMC members set their long-term target for the federal funds rate at 3.5%. Moreover, the falling potential growth rate of the U.S. economy means the ceiling on the rate is low. If the Chinese and other emerging economies lose more steam, and if that weighs on the U.S. economy, the rate of increase could be slower than targeted.