(MENAFN- Gulf Times) After almost a decade, the US Federal Reserve Bank is likely to increase the Federal Funds rate for the first time today. A 0.25% rate hike is almost a done deal, but the financial markets' focus will be on the following statements, which might give some clues on how much further rate hike is likely in 2016 and following years.
Fed rates hiking cycles since 1980:
The first major rate hike started on May 2, 1983, and ended on August 21, 1984, and the rates moved from 8.5% to 11.75%. Next cycle started on December 16, 1986, and ended on September 4, 1974, and the rates increased from 5.875% to 7.25%. The next cycle was from March 29, 1988, to February 24, 1989, and the rates moved from 6.5% to 9.75%.
From February 4, 1994, to January 1, 1995, Fed rates increased from 3% to 6%. Next major cycle started on June 30, 1999, and ended on May 16, 2000, and the rates moved higher to 6.5% from 4.75%.
Last but not the least, hiking cycle started on June 30, 2004, and ended on June 29, 2006, with rates moving from 1% to 5.25%.
Market exuberances following Fed's earlier rate hikes:
During 1986-89 rates hike cycles, on October 19, 1987 ( Black Monday), US Stock markets cashed with Dow shedding over 513 points or about 22.8% of its market capitalisation on a single day. This was followed by the Mexican Peso/Asian currencies crisis in December 1994, technology (dot-com) bubbles in March 2000 and US Sub Prime (Housing) bubbles in 2016.
Market reactions to the earlier Cycles:
People generally argue that the Fed's rate hike might make investments in US Dollar more attractive and funds may move from other countries especially emerging markets to US and this can create panic selling in currencies, commodities equities and debt markets.
However, a further review of market movements during the earlier cycles has shown mixed market reactions and on several occasions dollar collapsed and currencies, commodities etc" have rallied. Reasons might be political and economic conditions might be different at different occasions.
Has the Global Economy recovered enough to absorb the shock of the Fed rate hike?
No doubt, the US is the prime mover in economic recovery, following the subprime crisis. Europe, Japan and some other major economies are still going through recession/continued slowdown. Some of the emerging markets are also in the same boat. In this context, IMF has recently expressed its view that a Fed rate hike in 2016 is more appropriate and desirable.
Why should Fed hike rates?
With current unemployment rate at 5% compared to 8% in January 2013 and 2,308,000 new jobs added in the first 11 months of this year, FOMC members strongly argue for a rate hike today. However, GDP growth rate and other major indicators are mixed and still showing signs of sluggishness, which means any rate hike will be only symbolic and moderate.
What are the market expectations on Fed rates hike?
According to most of the market analysts, a 0.25% hike today is a done deal but a 0.5% hike or no hike can surprise the markets. Further, Fed funds rate hike in 2016 will be gradual and up to 0.75% and this cycle of rates hike might peak around 3.5% by 2018.
Dollar Index and Dollar strength:
Dollar Index has rallied substantially higher from 78.9 on May 31, 2014, to over 100 recently. This substantial rally was mainly due to weakness in Euro, commodity currencies and slowdown in China, rather than US economic strength/growth.
US national debt:
With over $18.8tn public debts, the US is the major beneficiary of almost 'zero interest rates', which remained so for over six years. The current US national debt per citizen is about $58,400 and it increases by $2.35bn a day. In other words, a one percentage increase in the rate might increase the interest burden of the US by $188bn a year.
What are the immediate reactions to Fed's hike?
Currencies of countries like the UK, where the current account deficit is highest (6.2% of the GDP) and Australia, where the foreign ownership of government bonds is the highest (about 65%), are more vulnerable compared to currencies of countries having moderate current account deficit and foreign holding of government bonds.
Initial reaction to the rate hike might be some funds moving back to the US, especially from emerging markets which might result moderate dollar strength, panic selling of currencies, commodities etc.
However, as indicated earlier, a 0.25% rate hike is a done deal and is priced in the current dollar strength. The real fire can be if the Fed hikes rates 0.5% this time or give indication of substantial rate hikes in 2016, following the FOMC meeting.
K V Samuel is executive manager
(Treasury & Investments) at Doha Bank.
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