Illustration copyright Gennady Safonov/TASS
The US Federal Open Market Committee on Wednesday raised its benchmark rate by 0.25 percentage points to a range of 1.25-1.5%. The American central bank is thus gradually tightening its monetary policy.
This is the latest rate hike under current Fed Chair Janet Yellen, followed by Jerome Powell early next year.
Experts expect that he will continue to tighten monetary policy: during the 2008-2009 crisis, the American central bank cut rates to almost zero, and also carried out large-scale asset purchases using newly printed money (these operations were called “quantitative easing”, or QE).
Just a few years ago, the Fed’s policy largely determined the state of global financial markets: flows of money from the American central bank flowed into developing countries, leading to the growth of their markets and strengthening currencies, and also contributed to rising oil prices after the 2008-2009 crisis. The first steps to tighten monetary policy in 2015 led to a fall in markets.
Now the influence of Fed policy has noticeably decreased. The BBC Russian service looked into how the Fed's rate hike will affect the ruble, the Russian market and oil prices in the long and short term.
Why won't markets fall after the Fed's decision?
"Markets have already priced in the Fed's rate hike," Renaissance Capital economist Charles Robertson told the BBC.
The same is stated in the report of the investment division of Sberbank (Sberbank CIB): “the increase in rates has already been fully appreciated by the markets and in itself will not lead to any market reaction.” According to the bank's analysts, the market's reaction will depend on the Fed's forecasts for 2018 - the regulator usually gives a signal about how rates will rise next year.
The market now assumes that the Fed will raise rates 2-3 times next year, Robertson explains. Emerging markets may react if the Fed gives a signal that next year they will raise rates by 3-4 times, the economist explains.
The change of the head of the Fed limits the significance of any assessments, Anton Tabakh, chief economist of the Expert RA agency, disagrees. After a series of new appointments, the dynamics of rate increases may change, he explains. At the beginning of next year, there will be a number of personnel changes at the Fed: not only the head of the Central Bank will change, but also a number of high-ranking officials of the American central bank.
Why does the Fed's policy have less and less impact on emerging markets and Russia?
Fed policy, according to Tabach, has less impact on emerging markets than before, and for other reasons: the investor base in emerging markets has become broader.
This year, the Fed has raised rates three times: at the beginning of the year, the rate was only 0.5-0.75%. Markets in developing countries are growing much faster than those in developed countries. Thus, the MSCI index for developing countries grew by almost 27.7% in 2017, while the British FTSE 100 index added only 7.7%, and the American S&P 500 - 17.5%.
Economists in various reports explain the growth of emerging markets by the acceleration of their economies, for example, the growth of the Russian economy accelerated, and in the middle of the year, many experts, although only slightly.
Tabakh also names another reason: Fed policy changes have become more predictable. They are announced in advance, and investors can “build them into the price,” the economist explains.
The Fed sets rates for the US economy, but the regulator is also concerned about how its actions will affect confidence in global markets, Sberbank CIB chief strategist Tom Levinson explained to the BBC. "US rates are rising, but the gradual rise in rates is supporting emerging markets," the economist explained. Levinson does not see that rising rates can somehow affect the ruble exchange rate.
"The Fed's policy remains soft. This softness means that a lot of money is distributed around the world, including Russia," Robertson adds. According to him, Fed rates, even after the increase, are still significantly below the combined level of economic growth and inflation.
Will rising rates in the US affect the ruble and oil?
In recent months, the ruble exchange rate has actually become untied from oil prices, experts and officials of the Russian Ministry of Economic Development believe. One of the reasons for this is carry trade operations - when investors make money on the difference in interest rates in different countries. They borrow currency from a country with low interest rates, like the United States, and buy currency from a country with high interest rates, such as Russia. And then they invest the money in bonds, which brings additional income.
“Carry trade will inevitably decline on both sides - from rising rates in the United States and from their reduction in Russia,” explains Anton Tabakh.
“Most likely, we will not see a strengthening of the ruble next year; most likely, there will be a weakening,” he believes.
Both Tabakh and Levinson noted that the oil market is almost now independent of the Fed's policy. “Oil prices are now determined by supply and demand factors in the energy market,” explains Levinson from Sberbank. This essentially means that Fed policy will not affect them.
On Wednesday, September 26, the US Federal Reserve raised its base rate by 0.25%, to a level of 2-2.25% per annum. This decision was made by the Federal Reserve's Open Market Committee following a two-day meeting in Washington. Previously, the American regulator raised the rate in June to 1.75-2%, and during a meeting in early August it maintained the status quo.
According to experts interviewed by RT, the Fed’s actions were expected. In their forecasts, analysts excluded the possibility of the rate remaining at the same level and highly assessed the likelihood of it reaching the range of 2-2.25% per annum. Moreover, according to data from the Chicago Mercantile Exchange CME Group, immediately before the meeting of the US Central Bank, 95% of respondents expected a rate increase of 0.25%, and only 5% of respondents - by 0.5% (to 2.25-2.5%). per annum).
The Fed's decision was supported by economic statistics from the United States. As follows from the materials of the US Department of Labor, in August core inflation in the country (excluding prices for energy and food) accelerated to 2.2%, but still remained close to the Fed target of 2%.
Let us recall that the global financial crisis forced the Federal Reserve to soften monetary policy and lower its interest rate. Thus, on December 16, 2008, a record low range was set - from 0 to 0.25% per annum. This measure was taken to stimulate economic growth during the recession - loans became cheaper, and, consequently, the level of consumption and investment began to grow.
The American central bank took a course towards increasing interest rates only in December 2015.
“During the 2008 crisis, the United States was the first to introduce a quantitative easing program, beginning to supply free liquidity to financial markets. In the current situation, in order to prevent its economy from overheating and to avoid inflating another “bubble” on stock exchanges, the Fed is systematically and carefully following the path of increasing the interest rate,” explained Finam Group analyst Sergei Drozdov in a conversation with RT.
In its monetary decisions, the Federal Reserve primarily relies on the inflation rate in the country. After a protracted easing policy, the rate hike is intended to curb the acceleration of consumer prices. Andrey Bezhin, director of consulting and brokerage services at QBF, spoke about this in an interview with RT.
“The Fed needs to keep the rate at the inflation level (this is a neutral level) or slightly higher to prevent prices from rising. A lot of money has been printed in the system since 2008, and economists naturally fear that this situation will sooner or later provoke hyperinflation,” Bezhin noted.
As the expert emphasizes, the Fed itself so far notes the absence of serious inflation risks. However, concerns about accelerating prices remain. First of all, they are related to what is observed in the world today, as well as Donald Trump’s tax reform. Although most experts today predict only a short-term impact of these factors on inflation in the United States, some economists believe that the consequences could be long-term, Bezhin added.
Forex Club Group analyst Mikhail Rytik emphasized that the American economy today is suffering from trade, so the country needs new investment resources. Tightening monetary policy, in turn, makes it possible to attract additional capital. At the same time, this situation leads to an outflow of funds from emerging markets.
“When rates are raised in the short term, the currencies of developing countries traditionally come under pressure, as investors abandon investments in them in favor of more reliable US government bonds and deposits in American banks (they also raise rates following the Fed),” the expert emphasized.
Without unnecessary movements
In a conversation with RT, Andrei Bezhin recalled that in its latest forecasts, the Fed promised to carry out four rate increases in 2018. The first two were made in March and June, so analysts expected to see the rate increase twice more - in September and December. Against this background, the markets had already been prepared for a long time, and the Federal Reserve’s decision did not come as a surprise to them. That is why experts interviewed by RT do not expect a strong reaction from financial platforms and world currencies to the results of the Fed meeting.
“The dollar is likely to strengthen moderately - expectations of an increase are already largely included in current prices. The US stock market may react with a slight correction, and the dynamics of emerging markets will likely be neutral - the currencies of these countries may continue to strengthen under the influence of internal factors,” added Anton Pokatovich, chief analyst at BCS Premier.
At the same time, experts emphasize that any other action by the American regulator regarding the base rate could provoke serious concern among investors. For example, according to Pokatovich, a sudden increase of 0.5% instead of 0.25% would lead to panic among investors and increase the fears of players about the stability of American markets.
“The rate would hardly have been increased by 0.5%, as this would have led to a sharp rise in the dollar exchange rate. Such a situation would have a negative impact on the state of the American economy, which does not benefit from a too strong dollar,” added Mikhail Rytik.
At the same time, in the long term, the national currency of the United States can still continue to gradually strengthen. According to Sergei Drozdov, as long as the Fed moves away from a soft monetary policy, the dollar will remain more attractive relative to other world currencies.
“As for the reaction of the Russian currency, in my opinion, an increase in the interest rate by the American regulator is unlikely to have a serious impact on the ruble, since in the current situation of the national currency, despite high oil prices, it largely depends on the sanctions agenda, within the framework of which there remain risks of the introduction of further restrictions by the United States regarding Russian government debt,” the analyst explained.
In general, according to experts surveyed by RT, following the Fed, a number of countries (especially developing ones) will also continue to raise their own interest rates.
The next meeting of the US Federal Reserve will take place on November 7-8. As follows from CME Group data, today most market participants expect a rate increase to 2.25-2.5% in December.
Since the end of 2015, the US Federal Reserve has begun normalizing monetary policy. The essence of this process is to bring the level of the effective federal funds rate to a sustainable level in the long term (currently estimated at about 4%), as well as to remove from its balance sheet the excess assets that the regulator acquired as a result of the quantitative easing program.
In December 2015, the rate was increased for the first time in 11 years by 0.25 percentage points. from near zero level. The next time the interest rate increased occurred only a year later - in December 2016, with a shift to the level of 0.5-0.75%. This year, the process of normalizing rates has accelerated, and two increases have already occurred - both of 25 basis points, and following the results of the December meeting, which will end on December 13, the interest rate is highly likely to be increased for the third time.
Why does the Fed raise rates?
Fed officials continue to argue that the rate hike is linked to expectations that inflation will rebound in the United States as the economy grows. Now the regulator is pursuing a policy to protect against a possible surge in inflation in the coming months due to the introduction of tax reform, which involves a significant reduction in the tax burden on business.
Tax reform in the United States is a key driver of high “risk appetite” in global stock markets: its implementation will accelerate US GDP growth next year to 2.0%-2.4% and accelerate inflation dynamics. In addition, the impact of Donald Trump’s presidential program on the economy in 2018, if it extends over 2-3 years, is estimated at 0.6%-0.8% of GDP, since part of the stimulus will most likely be used to repay debts and leveling out the slowdown in current growth rates. Against this background, the Federal Reserve is in a hurry to raise interest rates in order to create a basis for easing business conditions in the event of the loss of growth momentum and the US economy moving towards recession.
In February 2018, the post of head of the Fed will pass from Janet Yellen to Jerome Powell, but this will not change the direction of monetary policy in the United States. Despite the fact that the new head of the Federal Reserve is characterized by softer views, the market expects at least two more rate hikes in 2018 to 2%.
Thus, by the end of next year, the economy and financial markets may fall into an unpleasant trap: interest rates are rising, the Fed is determined to prevent inflation from rising above its 2% target within a year, while the US economy is not seeing much effect from tax reform and, according to forecasts, the rate of GDP growth begins to gradually slow down to 2% - this level can be reached in the fourth quarter of 2018.
What should an investor do?
What are the dangers of raising the federal funds rate to 2%? The fact is that, provided that long-term inflation expectations remain at about 2%, an increase in interest rates has the greatest impact primarily on the short part of the curve, pushing LIBOR rates and Treasury yields with a maturity of up to two years higher. . As a result, by 2019, “short” rates may be higher than “long” ones, which will negatively affect the dynamics of the financial sector. This inversion of the curve is often called a harbinger of recession.
This situation may be exacerbated by a liquidity shortage in the banking system due to the fact that the Federal Reserve, in parallel with raising rates, has begun to reduce its balance sheet. From October, the volume of assets under management of the regulator will be reduced by $10 billion per month, while sales are expected to increase quarterly with the goal of reaching $50 billion per month.
At the same time, an increase in the US government budget deficit in connection with tax reform may have a positive impact on the state of the stock market, fueled by both a decrease in multipliers and the likely announcement of plans by the largest corporations to conduct a buyback and pay increased dividends.
However, the expansion of the budget deficit creates medium-term threats to the Treasury bond market due to the high dependence of the US budget on market attractions of government debt and capital inflows. So in the future, the US Treasury may face an increase in borrowing rates and an increase in the cost of servicing debt obligations.
Given the reluctance of the European Central Bank to rush to raise the key rate, as well as taking into account expectations for the US economy, the euro-dollar pair may fall to the range of 1.14-1.16 per dollar by the end of the year. However, by the middle of next year, the euro may well strengthen to 1.20-1.25 per dollar - economic processes are unlikely to allow the ECB to delay normalizing rates, and fiscal stimulus in the United States will be extended over time, which will significantly smooth out its impact on the American economy , which is in a mature growth phase.
In general, the beginning of next year looks quite rosy for the stock and bond markets of both developed and developing countries. Risk appetite will be maintained at a high level, which will push stock indices to new highs, and inflows into high-yield assets can be converted into strengthening currencies of developing countries. The Federal Reserve's further monetary policy, which carries risks of curve inversion, may rather become a good reason for taking profits on risky assets in the second half of next year.
On Wednesday, December 19, the US Federal Reserve System (FRS) will make a decision on the base interest rate for the last time this year. According to analysts surveyed by Forbes, the Federal Reserve will raise rates, as the market expects, despite a noticeable drawdown in the American stock market.
Based on the values of futures for fed funds rates, it is highly likely that the rate will increase at the December meeting, explains investment strategist at BCS Premier Alexander Bakhtin.
The market has set a scenario for an increase in the rate by 25 basis points to 2.25-2.5% per annum, and all current macroeconomic data from the United States indicate that the Fed will not take another pause in tightening monetary policy, says leading strategist at Aton Andrey Kaminsky.
In November, US unemployment remained at 3.7%, the lowest level in almost 50 years, and inflation was 2.2% in annual terms - even higher than the Fed's target of 2%.
Even the emerging correction in the American stock market will not stop the Federal Reserve. Since December 13, all major US indices have shown strong declines: the S&P 500 fell by 4%, the Nasdaq by 4.7%, and the Dow Jones 30 by 4%.
Since the American regulator, when making a decision on the rate, relies on the dynamics of macroeconomic indicators, it has no reason yet to change course due to a fall in quotes, Igor Klyushnev, head of the trading operations department of Freedom Finance Investment Company, is sure.
What will happen to the market and the dollar?
The rate increase is an expected decision, and current securities quotes have already reflected its impact, says Klyushnev. “The decline in indices may temporarily intensify after the publication of the Fed decision, but it will not last long,” says the financier.
For investors, the statements made by Federal Reserve Chairman Jerome Powell will be more important. Analysts expect the rhetoric to soften and hints at a slowdown in rate increases.
The receipt of such signals will have a positive impact on the American market and may lead to an increase in quotes, but at the same time weaken the dollar exchange rate against major world currencies, Klyushnev notes.
If the Fed tightens its rhetoric - and such a scenario cannot be ruled out - the market will face a difficult time. “The United States has set a course for strengthening the dollar, attracting capital from developing countries and increasing the yields of its debt securities, so a gradual increase in rates is what is needed to achieve both economic and political goals,” says Alor Broker analyst Alexey Antonov.
In his opinion, after the rate increase, the S&P 500 index will continue to decline to a level of 2400 points, the euro-dollar pair will tend to 1.1 over the next six months, and towards parity over the next year, if the current Fed policy is maintained.
Impact on Russia
If the Fed's rhetoric softens, the positive sentiment of American investors will gradually spread to other capital markets, including the Russian stock market, says Anton Kostin, asset manager at Sistema Capital.
The Fed's policy may ultimately affect the ruble exchange rate and the yield of Russian securities. “The rise in rates in the United States is forcing the Russian Ministry of Finance to raise the OFZ yield in order to restore the narrowing gap between the yield of bonds in dollars and in rubles. A decrease in the difference between ruble and dollar yields would be a signal for foreign investors to sell OFZs, and this would lead to a sharp weakening of the ruble,” explains Igor Klyushnev.
According to the analyst, the Fed’s decision will not in any way affect future decisions on the Central Bank’s key rate. “On December 14, the Bank of Russia raised the rate in advance, even before the Federal Reserve meeting, so as not to provoke an outflow of investors from the OFZ, since it is known that the Federal Reserve is highly likely to raise the base interest rate. However, after the Fed meeting, actions to change the key rate will not be required,” explains Klyushnev.
However, if the Fed rate hike cycle continues, the dollar will strengthen, and the ruble exchange rate will see a noticeable decline. According to Alexey Antonov, the dollar to ruble exchange rate will exceed the 70 ruble mark even before the new year, and after the Christmas holidays the fall of the ruble may intensify.
On December 16, 2015, the US Federal Reserve raised its key rate by 0.25%. This caused considerable resonance in the global economic community - after all, the last time the rate was changed was in mid-2006. What is the need for such changes, and what can they lead to?
What is the base interest (key) rate?
This indicator represents the percentage at which banking organizations borrow funds from the country's Central Bank (in America, its functions are performed by the Federal Reserve). The interest rate at which banks issue loans to ordinary citizens cannot be lower than the established key rate - otherwise credit institutions will begin to operate at a loss. The 2008 financial crisis, which began in America and gradually spread throughout the world, forced the American authorities to take an unprecedented step and reduce the key rate to a record low level, ranging from 0 to 0.25%.
The temporary measure aimed at stimulating the economy and getting out of the current difficult financial situation dragged on, and the base interest rate was changed upward only in mid-December 2015.
How will a change in the Fed key rate affect the dollar exchange rate?
According to analysts, changes in interest rates will have a significant impact on the dollar exchange rate against the ruble (). Thus, the rating agency Moody’s prepared a report indicating the significant vulnerability of the Russian economy to changes in the domestic financial policy of the United States. The same opinion is shared by I. Didenko, who is a member of the International Union of Economists. According to him, raising the key rate will lead to a strengthening of the dollar and, as a result, a depreciation of the ruble.
Russian analysts, who are government officials, are much more optimistic. Deputy Chairman of the Central Bank of the Russian Federation S. Shvetsov announced the likely strengthening of the ruble and a depreciation of the dollar.
E. Nabiullina, who holds the post of head of the Central Bank, noted that the ratio of the ruble and the dollar is influenced by a combination of many factors, including oil prices, the foreign policy situation in the world, the economic interaction of Russia with partner countries, so a change in the key rate will not have a significant impact influence on the value of the dollar.
The head of the Ministry of Economic Development A. Ulyukaev said that the decision made by the Fed did not come as a surprise to anyone, and the expected increase in the key rate was taken into account when concluding contracts for oil supplies.
A change in the US Federal Reserve key rate by 0.25 points increased the value of the American currency on the world market. However, the rather insignificant size of this indicator allows us to conclude that there will be no radical jumps in the exchange rate - for example, since the decision was made to increase the rate, the dollar exchange rate relative to the ruble has increased by no more than a ruble. Oil prices have a much greater impact on the ruble exchange rate ().
