FED Rate Hike Decisions

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.