Janet Yellen Signaling Confidence in U.S. Economy
After seven years of near-zero interest rates, the Federal Reserve has decided to raise the cost of borrowing from 0.25% to 0.50% and the discount rate from 0.75% to 1.0%. The Fed had kept the benchmark rates set by the U.S. central bank at record-lows of zero to 0.25% since December 16, 2008, making this unique period exactly seven years long.
The last rate hike in the United States was set in June 2006, when Ben Bernanke, who had only been at the Fed’s command for five months, decided to increase the cost of borrowing to 5.25%. Explaining today’s announced interest rate increase, the Fed emphasizes that monetary policy remains “accommodative” regardless and that any new rate hikes will be “gradual.” The Federal Open Market Committee (FOMC) made the decision unanimously.
Markets moved quickly following the decision. The appreciation of the dollar and the simultaneous depreciation of the euro and the renminbi (the Chinese yuan), the currencies of the United States’ two major economic competitors, were the likely factors that tested the Fed’s caution. Hints of the caution remained in Yellen’s message: she repeatedly explained that the rate hike will be gradual and that the cost of money will remain low for a long time.
Nevertheless, the Fed must also contend with the effects of a strong U.S. dollar and American economy. The greenback has been trading at its highest-ever levels compared to the euro, with which it is heading toward parity. It is sitting around a six-year high compared to the Canadian dollar, setting record-highs against the Mexican peso as well.
Higher interest rates are bullish for the U.S. dollar, but the Fed’s move could crimp economic growth. As the greenback strengthens, U.S.-made goods become more expensive relative to other countries. This could crimp American manufacturing.
A strong U.S. dollar could also have important implications for other nations. A rate hike is not welcome in Beijing and the People’s Bank of China may try to further decouple from American monetary policy, given that at this time, China has no room for monetary tightening. China could then respond with more devaluations.