Three regional Federal Reserve Banks from Kansas, Dallas, and Philadelphia continue to encourage the central bank to increase rates being charged to commercial banks specifically for emergency loans.
Prior to the policy meeting held December 16 and 17, directors of the three banks made a request to the Board to boost the discount rate from 0.75% to 1%. However, the decision not to raise rates favored the other regional Federal Reserve Banks that have pushed to keep the rate as it is.
A number of economists anticipate that rates will begin to increase during the middle of the year but because there have been some developments in critical financial markets, the Federal Reserve Bank may choose to wait.
As indicated by Mark MacQueen, Sage Advisory Services’ portfolio manager, in looking at the market, it appears the Federal Reserve will not increase the rate as early as some believe. In fact, specific to the Federal funds futures market, a rate increase may not happen until sometime in September.
In a statement from Cheng Chen, US rates strategist with TD Securities, short positions value for the Eurodollar futures market dropped 86% to $14.5 billion for week-ended January 6. What makes this so important is that short Eurodollar futures are used by investors to hedge increasing interest rates so when short positions drop, it shows that a large number of investors do not expect a hike in rates anytime soon.
Measuring the annual inflation level expected by investors from 2020 to 2025 is the five-year forward five-year break-even rate, which declined to 1.86%, the lowest reported dating back to December of 2000.
In the meantime, the hike request made by the three regional Federal Reserve Banks would normalize the spread between the overnight Federal funds rate and discount rate for lending to banks. Of all economic levers, this is the main one for the central bank, which has remained locked in to a range of 0% to 0.25% for years. Before the most recent financial crisis, this spread was at 1% but to facilitate liquidation, it was cut by the Federal Reserve Bank.
The directors of all 12 regional Federal Reserve Banks feel there is improvement with the US economy although several of them also believe there would be wage pressures coming, primarily for jobs whereby workers must possess specialized skills.
Overall, the directors were more confident about growth in the economy for the future but there were still some who noted weakness overseas as being a possible risk to the economy in the US.
Some experts feel the central bank is moving too slow to increase rates, as well as reverse certain elements of the easing program. One economist stated that the Federal Reserve Bank is going down a well-known and dangerous path, adding that the bank is in denial about mistakes made in the past and taking the same approach that led to the financial crisis. As such, consequences could be just as bad as they were in 2008 and 2009.
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