The Federal Reserve’s policy makers, the FOMC, meet today and tomorrow (Wednesday) to review the economy and monetary policy. The minutes of the April meeting and recent comments by various FOMC members point to no change in interest rate policy at this meeting. Recent economic news is upbeat and the debates over the weak first quarter GDP have been largely forgotten. Barring a combination of a renewed plunge in oil prices and sluggish economic reports, the Fed funds rate is likely to be 25 bp later this year, possibly as soon as September.
The first rate hike isn’t something to worry about. Developed country financial markets should react quickly and briefly and settle down within a day or two. The big question is how long the Fed waits before making another move to a 50 bp Fed Funds rate. If a quick second step comes before the end of this year, market participants will either think that the Fed sees a lot more inflation than anyone else or that it feels it is behind the curve and waited too long to act. Either way, markets are likely to push yields higher.
The prospects are different in emerging markets. While the funds rate is a US benchmark and the Fed is the American central bank, both the rate and the Fed matter around the world. The reason the IMF argued recently that there is no reason to raise rates until 2016 was to delay reactions in emerging markets. Many emerging economies took on new debt in the last few years. Many also depend on exports of oil or other commodities and are suffering with lower prices. This combination of higher debt and less income means that some emerging markets are likely to investors look for other opportunities as markets decline when the Fed moves.
The FOMC will issue a statement tomorrow at about 2 PM Eastern time. It will be carefully read for hints of when a move might come: September, October or December. Further signs of a strong economy with gains in housing and business investment as well as labor markets will point to September.