Analysis: The end of an economic era, in name only

US Federal Reserve Bank expected to raise interest rate Wednesday.

The Federal Reserve Bank of New York (photo credit: GRYFFINDOR/WIKIMEDIA COMMONS)
The Federal Reserve Bank of New York
If the US Federal Reserve Bank raises the interest rate on Wednesday, as it is widely expected to do, it will mark a historic and notable turning point in the post-financial crisis era. But it will not mark an end to that era.
Federal Reserve Chairwoman Janet Yellen has carefully telegraphed her expectation that in December, for the first time in nearly a decade, rates will rise – but only ever so slightly.
“The question isn’t when, but to what extent? What’s the way forward,” says Ofer Klein, head of Harel Insurance and Finance’s economics and research department.
Since the financial meltdown in 2008, central bankers around the world have dropped interest rates to near zero levels to goad their economies out of recession.
The Fed’s aggressive action, alongside unconventional policies such as quantitative easing – buying financial assets from commercial institutions and not just financial ones – helped the US avoid a depression.
Yellen’s predecessor Ben Bernanke said interest rates wouldn’t rise until unemployment dropped below 6.5 percent, a target the economy hit long ago. Then, when the Fed started to pull back its quantitative easing policy, rates were expected to rise within half a year, another mark long since passed. But continually moderate economic growth, sluggish increases in wages and low inflation, not to mention economic malaise abroad, kept the interest rate at zero.
Why increase them now? Not everyone is convinced that it is the right move. Some argue that an increased rate will make the dollar too strong and hobble economic growth, while the rest of the world deals with repercussions.
Emerging markets, already hurting from a fall in the prices of commodities they export, may have trouble paying dollar-denominated debt as the dollar gets stronger, which could be its own source of trouble.
But on the other hand, the world cannot live in a zero-interest rate environment forever, and Yellen does not want to harm the Fed’s credibility after hinting so strongly at a rate rise. Thus, in all likelihood, Wednesday’s decision will mark a turning point, the moment when the US finally began writing the last chapter on the financial crisis.
Just don’t expect that last chapter to be short or decisive.
The US interest rate may rise Wednesday, but it will probably only do so by a quarter of a percentage point. The real question, then, is how long it will take for subsequent rate increases.
“I would characterize this as the first step of a very prolonged process that will start to come back to normality in the US economy,” says the Interdisciplinary Center Herzliya’s Rafi Melnick.
But what does all that mean for Israel? In some ways, it will mean very little.
“We can’t anticipate that there will be some meaningful effect.
It’s more declarative than meaningful,” says Epsilon Investment House’s chief investment manager Idan Azoulay.
The markets are already expecting an interest rate increase, so they may not have a strong reaction, though the Fed’s forward guidance on how quickly rates will rise may have an effect.
The increasing rate is also somewhat offset by the monetary policy of the European Central Bank, which is ramping up its quantitative easing program. Because Europe is a larger trade partner to Israel than the US, the diverging policies may in effect “cancel each other out” when it comes to the Bank of Israel navigating its own monetary policy.
That said, it will also make the shekel relatively weaker against the dollar, and relatively stronger than the euro.
“In terms of Israeli exports, Europe gets more low-tech and agriculture, while the US gets more high-tech, so it might affect the respective industries differently,” notes Klein.
For six years, the Federal Reserve has been in uncharted territory.
An interest rate hike would be the first step back toward a more conventional monetary policy.
But like any traveler navigating his way out of the woods, the Fed may still take some wrong turns along the way.