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Economy: Federal Reserve could hike interest rates sooner than expected

  • US economy growing more rapidly than expected
  • Federal Reserve could raise interest rates to 0.6% by the end of 2023
  • The Fed was not expected to hike interest until 2024
  • US dollar (USD) soared to a near six weeks high on Wednesday
  • The US sees jobless claims fall below 400,000
  • Delta covid variant to become a dominant source of new coronavirus infections in the US
  • Stocks fall following indications of tighter US monetary policy
  • US/UK reach agreement on Airbus/Boeing trade dispute

The Federal Reserve stated during yesterday’s monetary policy meeting that US interest rates could be increased sooner than anticipated. The Fed previously announced back in March 2021 that they would delay hiking interest rates until at least 2024. However, due to the US economy recovering more rapidly from the coronavirus pandemic than expected, interest rates could rise from near zero to 0.6% by the end of 2023.

Last week it was revealed that the US consumer prices rose 0.6% in May 2021, which brought the annual inflation rate to 5%.

Additionally, it’s now thought that US inflation could reach 7% by the end of 2021, up from previous forecasts of 6.5%. The recent inflation growth experienced in May 2021 is the most significant rise since August 2008. The Federal Reserve set interest rates to near zero during the coronavirus pandemic to reduce borrowing costs and boost the US economy. However, with consumer prices now soaring, it’s feared that prices could soon spiral out of control.

The aim of increasing US interest rates sooner than expected is to help ease rocketing consumer prices and keep inflation under control. However, hiking interest rates can also significantly impact consumer and business loans, including credit cards and mortgages.

The Fed attributed the US’ swift economic recovery to the rapid rollout of coronavirus vaccines and President Joe Biden’s USD 1.9 trillion coronavirus stimulus bill. That being said, Fed Chair Jerome Powell highlighted that the significant rise in US inflation is likely to be temporary and revealed his optimism for further growth in US employment this year.

During the recent monetary policy meeting, there were also discussions surrounding easing the bank’s USD 120 billion bond-buying programme. Officials stated that the asset purchases could continue until there was further progress towards the bank’s maximum employment target and 2% inflation goal. However, the Federal Reserve Chair, Jerome Powell, did not give a specific timeline regarding the policy shift but stated that the Fed would communicate with the markets before deciding.

Tiffany Wilding, an economist at PIMCO, suspects that the tapering of asset purchases could occur as early as September and doesn’t believe that we will see a repeat of the violent selloff experienced in 2013.

Rick Rieder, chief investment officer at BlackRock, is doubtful that narrowing the bond-buying programme will cause tangible stress to the US economy and believes the most significant risk will be the unpredictability of rising wage costs.

US Dollars

US dollar (USD) hits near two-week high

The Federal Reserve’s revised decision on interest rates caused the US dollar (USD) to soar to a near six-week high against many of its key currency competitors, climbing up to 0.63% higher. Today the British pound to US dollar (GBP/USD) exchange rate is trading 0.16% lower at USD 1.3966, whilst the euro to US dollar (EUR/USD) exchange rate is trading 0.37% lower at USD 1.19.

Yesterday, the US dollar to Japanese yen (USD/JPY) exchange rate reached JPY 110.49, which is a 0.39% rise and the currency pairing’s highest level since 6th April 2021.

Currency analysts highlighted that whilst there will not be an imminent shift in US monetary policy, the Fed’s recent comments certainly provides further support for the Greenback. Martin Miller, Market Analyst at Reuters, states that the US dollar (USD) is likely to remain in demand due to the Fed’s increasingly bullish tone.

Mr Powell stated that the course of the US economy would continue to be directed by COVID-19, though maintained an upbeat tone on US economic recovery. Economists took notes that the Fed appeared to show a reduced tolerance for US inflation, a stance that many had misjudged.

US Interest rates remain near zero for the foreseeable future as Fed Chair Jerome Powell noted that the rising inflation was a transitionary factor prompted by the reopening of the US economy and the lifting of coronavirus restrictions.

Delta variant to become a dominant source of new coronavirus infections in the US

Whilst the number of coronavirus cases in the US has reduced significantly since the start of 2021, there are concerns regarding the rise of Delta variant cases. Former commissioner of the Food and Drug Administration, Scott Gottlieb, stated that the Delta variant is likely to become a dominant force in the US and suspects that there will be a significant outbreak of infections during the Autumn.

The Delta variant, also known as B.1.617.2, currently accounts for 10% of infections in the US, but it’s thought that this could double over the next two weeks. Additionally, with the variant said to be 60% more transmissible than the original strain of coronavirus, the US will likely require financial support from the Federal Reserve for the foreseeable future.

The US sees jobless claims fall below 400,000

It was made clear during yesterday’s US monetary policy meeting that the Federal Reserve will continue to support the US economy whilst COVID-19 remains a threat. Mr Powell noted that US citizens who cannot bear the burden of the US economic crisis had been the hardest hit, with many struggling to find employment.

Whilst US unemployment remains a concern, last month saw a significant reduction in jobless claims. During May 2021, US unemployment claims fell by 20,000 to 385,000. This reduction is the first-time jobless claims have fallen below 400,000 since the start of the coronavirus pandemic and is significantly below the 965,000 claims experienced during January 2021.

Rubeela Farooqi, a chief US economist at High-Frequency Economics, highlighted that the reopening of the US economy is helping to drive further job growth.

Around 25 US states are said to be removing unemployment benefits for millions of US citizens as it’s believed that the funding is preventing many from seeking work opportunities. However, there are conflicting views on whether the termination of unemployment benefits will lead to further hiring. Chris Rupkey, a chief economist at FWDBONDS, stated that removing unemployment benefits could reduce economic growth unless individuals can find new jobs quickly.

Stocks fall following indications of tighter US monetary policy

Whilst the US dollar (USD) was supported by yesterday’s comments from the Fed, stocks took a tumble at the announcement of tighter US monetary policy as the Dow Jones Industrial Average dropped by nearly 1%. Japan’s Nikkei dropped by almost 1%, while Australia’s S&P/ASX 200 and South Korea’s KOSPI both fell to nearly 0.4%.

Europe’s Stoxx 600 index fell by 0.3%, having experienced a record closing high yesterday.

Meanwhile, the FTSE 100 fell by 34 points or 0.5%, standing at 7150 points, having reached a new high since the coronavirus pandemic on Wednesday morning.

However, it’s not all negative news in the stock market. Banks appear to be on the rise, with Natwest up 1.6% and Barclays, Lloyds and HSBC all up 1%, as rising US interest rates could help to improve their profitability.

Travel stocks have also risen today following news that the UK could ease restrictions on holidays abroad for those who are fully vaccinated. As a result, IAG is up 3%, easyJet 3.9%, Wizz Air 2.9% and TUI 2.6%.

US and UK reach agreement on Airbus/Boeing trade dispute

The US and UK have today announced their new agreement concerning the 17-year Airbus/Boeing dispute. In alignment with the new Atlantic charter signed by US President Joe Biden and UK Prime Minister Boris Johnson last week, the US and UK have settled an ongoing trade irritant concerning large civil aircraft.

The new trade agreement was confirmed today by Secretary of State for International Trade Liz Truss and US Trade Representative Katherine Tai.

Both sides agreed to remove tariffs relating to the dispute for five years. As a result of the disagreement, products such as Scotch whisky, biscuits and clotted cream had previously been subject to additional 25% fees. The new agreement between the US and UK means these tariffs will be waived until 2026, when further talks will take place.

The Scotch Whisky Association predicted that over GBP 600 million in exports was lost as a result of the trade barrier. The trade dispute also impacted a variety of UK industries such as cashmere and construction vehicles.

Liz Truss stated that the trade agreement will take the US/UK trading relationship to the next level and enhance the alliance between the two countries.

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