DECEMBER 15, 2015
William A. Harris, CFA
Chief Investment Officer
Fed Likely Just to Nudge Rates, Stay Low for Longer
The Federal Funds Rate is the interest rate banks charge each other on overnight loans. It sets the starting
point for the entire term structure of interest rates. In essence, it determines “sea level” for the cost of
money in a financial system which, nearly as much as ever, is predicated on lending and borrowing.
Seven
years,
flatlined
near
zero
Consensus has it that the US Federal Reserve will exit seven years of zero interest rate policy (ZIRP)
when it meets this week, and start ratcheting the Federal Funds Rate higher. Consensus also has it that the
Fed will exit by raising rates 0.25% (25bp) at a time, though we believe there’s a chance they’ll opt for
smaller increments (12.5bp moves weren’t uncommon prior to the 1990s). In the last cycle, the Fed hiked
rates steadily up, up, up, by 4.25% in just over two years, but don’t expect a repeat of that pace. First off,
after staying flat-lined near zero for so long and eliciting little in the way of economic vigor, the Fed
should be disinclined to throw ice water by the bucket on an economic recovery which remains
inconsistent. Moreover, the Fed is constrained by a global environment where numerous foreign markets
are sporting negative yields on bonds maturing as far as two years out: In France, Germany, the
Netherlands, Sweden, Switzerland, and Japan, governments are being paid to borrow, while lenders pay to
lend. That global rate set may sound absurd, but it is a reality the Fed will have to respect or risk
distorting currency exchange rates and dislocating global trade. Since the Financial Crisis, globally
coordinated monetary policy has played well for the US; the Fed won’t rush to be at odds with the pack.
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