The Fed's Four Interest Rate Hikes

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Headlines:

  • Icahn sold one-third of his stake in crane maker Manitowoc last month
  • After the sales, Icahn owned 4.85% of the company, down from his previous stake of 7.5%
  • Shares of Manitowoc, which depend on steel to manufacture its products, dropped 4.8% on Feb. 16 after Commerce Sec. Wilbur Ross recommended a global tariff on steel imports

    Fed on track for 3 rate hikes in 2018, but 4? No sign in report to Congress

    • The Fed is on track of raising the interest rate 4 times this year
    • Speculation of US Economy growing too fast
    • Still very dubious of what the Fed is planning to do going forward

    History on FOMC
    There has been 3 Quantitative Easings in the United States, from 2008 up to 2013.

    1. Quantitative Easing 1 (November 2008): The US bought $1.25 billion Mortgage Bonds and $300 billion long-term Treasury Securities. This should have little effect on its balance sheet (Asset: Treasury Bonds and MBS, Liabilities: Commercial banks' money and cash in circulation)
    2. Quantitative Easing 2 (November 2010): The US bought $600 billion long-term Treasury Securities
    3. Quantitative Easing 3 (September 2012): Buying $45 billion long-term Treasury Securities

    The Fed buys those MBS and Treasury bonds through printing money. When the Fed buys them, more money goes into the economy. Why long-term Treasury Securities? At the time, short-term rate was extremely low, and by buying those long-term Treasury Securities, the Fed hopes to lower the long-term borrowing rates (mortgage, long-term debt, Treasury bonds, etc). QE succeeded in decreasing the long-term Treasury and mortgage rate by 1 percentage point, signaling to people that the Fed is making credit cheap and readily available until the Economy recovers from the Great Recession.

    What is going on right now
    Because of Quantitative Easing, The US has rebounded from the Great Recession, and as of now is keeping interest rates at a historically low level. The US target for inflation is 2%. However, in February, it was announced that the inflation rate was 2.1%. This was the reason the S&P 500 fell for the first time. The market thought that the economy may be over-heating and that hyper-inflation might ensue. As you may all see from the start of February to March, there has been around 2 more market drops. These are mainly because of the Fed weighing in options of whether they should raise interest rates. The main opinion against keeping the inflation rate low is that it provides little to no cushion for another economic downturn. And so, there are four things the Fed is considering tempering with the inflation rate:

    1. Raising inflation target
    2. Adopting an inflation target range
    3. Establishing a price level target
    4. Establishing a target for nominal GDP

    The first two options might not happen since they may compromise the Fed’s commitment to fighting high inflation and undermine the Fed’s ability to achieve target inflation rate. While options 3 and 4 might provide loose inflation targets and a lot of uncertainty going forward. 
    Looking at the market right now, I think Powell has not put much consideration into these options and is more inclined towards increasing interest rate.

    Why interest rate hikes are bad for the market
    Interest rates and Treasury bond prices have a negative correlation. As the interest rate increases, bond prices fall. When bond prices fall, the bond yield rises. This phenomenon explains the S&P 500 downturn these past couple of weeks. When the bond yield reached 2.8%, people got skeptical on putting their money in the market, since they are guaranteed to get 2.8% return from investing in long-term Treasury bonds. Thus, they take their money out of the market through selling their holdings. When this happens, the S&P 500 falls.

    Takeaway
    I do not have a certain answer whether the Fed will raise their target inflation rate or be more aggressive with interest rate hikes. But considering historical cases, it is more likely that the latter would happen.