The Federal Reserve System (Fed) tension experienced worldwide for a while ended on December 16. The US Central Bank acted in accordance with the Fed and increased the “federal funds rate” range to a 0.25-0.50 percent range. Let us take a look at the increase in interest rates and the phase after, and the effects that are likely to spread out into the world:
WHAT DID THE FED DO?
With the decision made a few days ago, the Fed made its first interest rate hikes since 2006. The factor leading to a hike was the continuous recovery in the US economy and this positively affecting the labor market. Inflation, the other indicator the committee that directs monetary policy follows, is still far from the 2 percent target. However, a statement made by the Federal Open Market Committee (FOMC) underlines that this target will be achieved in the medium term. The Committee says that slowly progressing inflation reminds us that there are effects arising from the energy and import goods prices, and states that these are ”temporary.”
Consequently, we can state that the primary aim in the rise in interest is to avoid the risks that come with overheating in the economy. I will not go into detail at this point, as I discussed this issue in my column on December 1.
The decision made in the December Fed meeting is actually only one step in the adventure it plans. The important thing is the route it chooses to take. We see the traces of an expected “gradual” approach in the statements. New savings will depend on the course of the economy. Holding “full employment” and “2 percent inflation” targets, the Fed will continue to observe many parameters in order to take the right course.
In addition to this, the bank follows a projectional calendar. Thus, in some way, the projections the board members and presidents make to evaluate the monetary policies they also expect to draw the road maps of interest. Looking at the median projections on this map:
Economic growth rate While 2.4 percent is expected in 2016 and 2.2 percent in 2017, 2 percent is expected in 2018.
Unemployment rate is expected to decrease from 5 percent to 4.7 percent between 2016-2018. This rate is projected to be 4.9 percent in the long term.
Expected inflation however, is forecast to be 1.6 percent in 2016, 1.9 percent in 2017 and 2 percent after 2018.
And within this context, the end of year interest projection increases between 2016-2018 as follows: 1.4 percent. 2.4 percent, 3.3 percent, respectively. In the longer term however, 3.5 percent is predicted.
Surely these indicators, especially the interest hike, will follow a course according to circumstances. There are so many dynamic parameters that will be evaluated by the Fed and take steps accordingly. While watching national data on the one hand, the FOMC, will watch out for foreign developments.
WHAT ABOUT THE DEVELOPING ECONOMIES?
While the Fed keeps an eye out on foreign developments, they will continue to watch the Fed, especially the developing economies... In my column on Tuesday, I noted that those rising are losing height and touched upon the related problems.
If we look at the last quarter of 2013 we see that there was a fluctuating capital inflow into the EMs, and when compared to the national dividends of 2015, the rates were at their lowest. Although China had an important effect on this development, most of these economies displayed negative pictures compared to their previous years. Investors leaving the EM market this year indicate a record rate for the first time in years.
Hence, there is concern for how much the conditions formed with the Fed's entering the expected track will continue to affect those developing. At this point, capital inflow and rates are the main reason for the uneasiness. The increase in the value of the dollar will upset economies that are not doing well with inflation. Thus, the effects of possible interest hikes in these economies are considered too. Pressure due to dollar debts are also a concern.
I would also like to point out that the period experienced till now, including all the exaggerations, has significantly valued the EM and Fed's increase in interest rates. The declaration that a gradual increase will come, however, moderates the possible unease. In addition, as I expressed earlier, the developing economies are on the verge of a test, and they themselves, to an extent, will determine how the new period that comes with the Fed will affect them.
This requires the central banks of states to follow “sensitive” policies. It also shows that the dedication of governments to economic transformation is critical within this scope. Thus, countries that increase structural constructions and inspire confidence have the opportunity to strip themselves of this situation and jump at a better chance.