FED
Rate Hike Decisions
The Fed
meets 10 times a year to decide on US interest rates.
Inflation:
- when demand starts overtaking supply we have a situation where the prices
will automatically start rising. In
other words inflation is too many people chasing too few goods. Once the economy reaches a stage whereby
aggregate demand starts overtaking aggregate supply prices will rise and so
inflation will set in. The central bank
of any country will respond to this by hiking interest rates in order to reduce
money supply in the economy and thereby curtail inflation. Thus from a trading perceptive it is
important for a trader to gauge whether inflation is setting in and whether the
central bank will move in to hike interest rates. The trade should therefore look at the
following data to check whether interest will go up.
Inflation
can take place in the following ways for which different data has to be looked
at.
Growth Push
Inflation
Price Push
Inflation ‘
Wage Push
Inflation
Demand Push
Inflation
Growth
Push: - this results as s result of
strong growth in the economy. For
ascertaining whether inflation is going up as a result of the growth we need to
look at the following indicators: - 1) GDP figures 2) Unemployment & 3)
Non-Farm Payrolls.
Price
Push Inflation: - This results
because of the prices going up. For
ascertaining whether inflation is going up as a result of the prices going up
we need to look at the following figures.
PPI Figures
CPI Figures
Wage
Push Inflation: - This results when
there is wage pressure and earnings go up. For ascertaining whether inflation
is going up as result of wage pressures we need to look at the following
figures:
Average
hourly earnings
Employment
Cost Index
Demand
push Inflation: -This results because
of demand pressures. That means that consumer demand is so strong that the
prices are pushed up as supply is not able to cope up with demand. For
ascertaining whether inflation is up as a result of demand pressures we need to
look at the following figures.
1-
Retail Sales
At any
point of time for the central bank to move in to hike interest rates it is
important that out of the above four factors at least three should indicate a
rise in inflation. Even if two of the above four indicate that there is a rise
in inflation there is a possibility that the central bank may move in to hike
interest rates but with three factors indicating inflationary pressures, hiking
interest rates becomes a certainty.
Eccles Building. Head Quarters of Federal Bank in Washington
D.C
Effect of Interest Rates:
Inflation goes up – Interest Rates go up
Interest Rates go up – The currency whose interest rate
has been hiked becomes stronger
So FED increases interest rates – US dollar becomes
strong.
FED decreases interest rates – US dollar becomes weaker.
Further
Interest Rates go up – Stock Markets & Bonds come
down & Vice Versa.
After the 2008 crisis the above might not be as simple as
described above, but traditional wisdom dictates this is how the FED would
respond.
A general rule of thumb is that if the FED responds by
hiking interest rates 3 times, the US economy goes into a recession.
