The Federal Reserve finally feels confident enough in the economy to begin raising interest rates. Hopefully this won't go horribly wrong.
Analysts and commentators have been predicting the move for over a year, but it wasn't until Wednesday that the central bank pulled the trigger. It increased the federal funds rate, the primary short-term interest rate benchmark in the United States, to between 0.25% and 0.50% -- the previous target range was between 0.00% and 0.25%.
It's a small jump, but a meaningful one.
The federal funds rate, the rate at which banks lend excess reserves to each other on an overnight basis, has been at or near zero essentially since Lehman Brothers declared bankruptcy in September 2008.
The Federal Reserve dropped it to the "zero bound" at the time to help cushion the economic impact from the crisis. Doing so made lending more profitable for banks and less expensive for borrowers, igniting a mortgage refinancing boom that filled the coffers of the nation's biggest mortgage lenders -- banks such as Bank of America, Wells Fargo, and US Bancorp.
While it's impossible to measure the precise impact that ultralow rates have had on the economy over the past seven years, it's reasonable to conclude that they helped the central bank fulfill its legislative duties to achieve full employment and steady prices -- its "dual mandate."
The unemployment rate sits at 5% today, after peaking at 10% in October 2009. And inflation has heretofore been a non-issue, coming in at 0.5% in November, compared with the 2%-3% range associated with stable economic growth.
While the Fed was driven to wait by an understandable fear of deflation, which has an incredibly pernicious impact on an economy, the bank's monetary policymakers expressed confidence that such fears have receded. "The committee ... is reasonably confident that inflation will rise, over the medium term, to its 2 percent objective," says the Federal Open Market Committee's press release.
This confidence aside, it's worth keeping in mind that we're in uncharted territory.
The financial crisis of 2008-09 was a once-in-a-century occurrence. While all economies experience recessions and even brief seizures of credit markets, you have to go back to the Great Depression of the 1930s to get a sense for the momentousness of the Fed's latest move.
Pessimists familiar with history will fear a repeat of 1937, when the Fed seems to have ignited the second half of the Great Depression by raising rates prematurely. Optimists will see the latest move as a signal that the economy has regained enough strength to operate without stimulus from ultralow borrowing costs.
Encouragingly, Richard Davis, the CEO of US Bancorp, casts his lot with the latter. As he noted in April:
As rates start to move up, I'm still convinced of two things. One will be that when there is a real sense that's about to happen there will be a tsunami effect, particularly on the corporate and wholesale side that people want to lock down low rates before they finally get stuck having missed that opportunity.
And consumers will move from those who have been saving their money, now they'll start making some real money in their savings accounts and their endowments and their long term trust and I do expect people to start using their lines of credit again feeling the strength of an economy and a higher wage that will come with it.
We already know that Davis' first hunch has at least partially hit the intended mark, given that 2015 will go down as a record year for mergers and acquisitions. Industry leaders such as Pfizer, Dow Chemical, and DuPont have seized on low rates to finance combinations with equally massive competitors.
Bank of America alone has advised on more than $1 trillion worth of deals this year, a threshold also eclipsed by Goldman Sachs, JPMorgan Chase, and Morgan Stanley. And of the $4.7 trillion in total deals announced in 2015, two are among the biggest in history, and nine are valued at $50 billion or more.
The big question now, and particularly as we enter the final throes of holiday shopping, is whether US Bancorp's chief has correctly read consumers' tea leaves as well. If so, it could be a boon to retailers. If not, then we're probably looking at more of the same -- a sputtering economy that looks more and more like Japan's with each passing day.
