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Federal Forces Run Up The Colors


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What's going on?

The US Federal Reserve (“the Fed”) raised its target interest rate for the third time this year and signaled it would do the same again next year – beating a continued retreat from the battlefield of ultra-low interest rates.

What does this mean?

The Fed raised its forecast for economic growth for both this year and the next, and stated that it would continue to raise interest rates if the economy grew as it anticipated. Notably, however, two of the Fed’s voters railed against the decision. One likely reason is inflation, which remains below the Fed’s target. If the Fed wants to focus on boosting inflation, it may have to pare back its interest rate increases (low interest rates spur inflation: partly by encouraging people and companies to borrow – and spend – money, increasing demand and therefore prices).

Why should I care?

The bigger picture: Central banks around the world are facing a choice between spurring inflation and stopping investment bubbles.

Low interest rates, globally, have encouraged investments (like stocks, real estate and, yes, bitcoin) to go up quite sharply in recent years: if government bonds offer a measly return, then investors typically look elsewhere. A major risk is that the investments they choose increase far too much in price relative to their underlying value – and then come crashing down as the bubble eventually bursts. In 2018, central banks may have to choose between tackling either low inflation or the ever-rising value of investments.

For markets: Investors interpreted Wednesday’s move as a sign that interest rate increases may slow next year.

Everyone and their dog expected the Fed to increase rates – so the market reaction is really more indicative of how investors think the outlook for next year changed. The US dollar dropped almost 1% versus other currencies, suggesting that investors think interest rates will rise more slowly than previously thought (how do interest rates impact the value of a currency? click here). The era of low interest rates may have some legs in it yet.

Originally posted as part of the Finimize daily email.

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