The Federal Reserve is widely expected to raise interest rates next week on December 16 for the first time in a year. The move would end an extraordinary period of near-zero rates that began in December 2008 during the depths of the financial crisis.
The Fed’s policy-making committee which sets rates is meeting this week. It is not expected to provide any new clues about its plans at a post-meeting news conference Wednesday.
Here’s a look at the possible scenarios for next week and what Fed watchers will be watching:
The most likely scenario is that the Fed will raise its benchmark rate known as the federal funds rate by a quarter point to a range of 0.50% to 0.75%. That would still leave rates at historically low levels.
The Fed has been telegraphing its plans to raise rates gradually for months. In September Fed Chair Janet Yellen said she expected rates to increase “relatively soon” provided the economy continued to improve.
Since then economic data has been generally positive. The November jobs report released last week showed that the economy added 178000 jobs slightly below expectations. But the unemployment rate fell to a nine-year low of 4.6% and wages increased.
Yellen and other Fed officials have said they want to see sustained improvement in the labor market before raising rates. They also want to be sure that inflation is moving toward the Fed’s 2% target.
Inflation has been running below the Fed’s target for more than four years. The Fed’s preferred inflation measure known as the personal consumption expenditures price index rose just 1.2% in the 12 months that ended in October.
Fed officials have said they think the low inflation readings are mostly due to temporary factors such as lower prices for oil and other commodities. They expect inflation to pick up next year as the economy strengthens.
One wild card next week is the presidential election. In her news conference Yellen is likely to be asked whether the Fed thinks Donald Trump’s election has created any new risks for the economy.
Yellen has indicated that she thinks Trump’s policies could have negative consequences such as increasing the federal budget deficit and sparking a trade war. But she has also said it’s too soon to know what if any impact Trump’s election will have on the economy.
The Fed is also likely to be asked about Trump’s pick for Treasury secretary Steven Mnuchin. Mnuchin a former Goldman Sachs executive and hedge fund manager has been a vocal critic of the Fed’s easy-money policies.
In an interview with CNBC last year Mnuchin said the Fed was “way behind the curve” in raising rates and that it was creating “a bubble” in the bond market.
Mnuchin’s views could have an impact on the Fed’s plans to gradually shrink its $4.5 trillion balance sheet. The Fed has been using that portfolio of securities to support the economy by keeping long-term rates low.
Mnuchin has said he would like to see the Fed start to unwind its balance sheet “reasonably soon.” That could put him at odds with Yellen who has said she wants to see more evidence of a strong economy before starting that process.
The Fed’s balance sheet reduction is another potential wild card next week. The central bank has been gradually shrinking its portfolio of Treasury and mortgage-backed securities and it could provide more details on that process next week.
The Fed has been gradually reducing its balance sheet since October when it started allowing a small amount of securities to mature without replacing them. The process is expected to take several years.
Some Fed watchers have been concerned that the balance sheet reduction could cause a spike in long-term rates derailing the economy. But so far rates have remained low.
In her news conference Yellen is likely to be asked about the balance sheet reduction and whether it could cause any disruptions in financial markets.
The Fed’s decision on rates next week is likely to be a close call. A number of Fed officials have said they think rates should be increased sooner rather than later.
But Yellen has indicated that she thinks the case for a rate hike is not yet “compelling.” It’s possible that she could wait until next year to raise rates provided the economy continues to improve.
The Fed’s decision next week will be closely watched by financial markets and the wider world. A rate hike would signal that the Fed thinks the economy is strong enough to handle higher borrowing costs.
But it would also be a sign that the era of ultra-low rates is coming to an end. That could have implications for everything from mortgage rates to stock prices.
When is the next time the Federal Reserve is expected to raise interest rates?
How often does the Federal Reserve meet to discuss interest rates?
Eight times a year
What is the Federal Reserve’s main tool for implementing monetary policy?
The federal funds rate
How does the Federal Reserve use the federal funds rate to influence economic activity?
Raising the federal funds rate makes borrowing more expensive and encourages people to save while lowering the rate does the reverse.
How does the Federal Reserve’s decision on interest rates affect the economy?
Higher interest rates tend to slow economic growth and inflation while lower interest rates stimulatethe economy and inflation.
What is the relationship between interest rates and inflation?
In general when interest rates rise inflation falls and vice versa.
What is the relationship between interest rates and economic growth?
In general when interest rates rise economic growth slows and vice versa.
What are some of the other factors that can influence economic growth?
Fiscal policy employment levels consumer confidence and international trade.
How does the Federal Reserve’s decision on interest rates affect the stock market?
Higher interest rates tend to cause the stock market to fall while lower interest rates tend to cause it to rise.
How does the Federal Reserve’s decision on interest rates affect the bond market?
Higher interest rates tend to cause bond prices to fall while lower interest rates tend to cause them to rise.
What is the relationship between interest rates and the dollar?
In general when interest rates rise the dollar strengthens and vice versa.
What is the relationship between interest rates and the housing market?
Higher interest rates tend to cause home prices to fall while lower interest rates tend to cause them to rise.
What is the relationship between interest rates and credit card rates?
In general when the Federal Reserve raises interest rates credit card rates will rise as well.
What is the relationship between interest rates and bank savings rates?
In general when the Federal Reserve raises interest rates bank savings rates will rise as well.
What is the relationship between interest rates and the stock market?
In general when the Federal Reserve raises interest rates the stock market will fall.