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Opinion

Opinion: Fed rate hike was overdue

Critics fear the US central bank's decision to raise its core interest rate will choke off growth in the United States or in emerging markets. But DW's Rolf Wenkel isn't worried, saying the move was long overdue.

Let's be honest: If Fed chair Janet Yellen had once again failed to raise interest rates, then she and her colleagues - the other Fed monetary policy governors - would have incurred a serious credibility problem for themselves. There's no way they could hint month after month that an exit from ultra-low, near-zero interest rates would come before the end of the year, and then in December say: Er, sorry, we didn't mean it.

On the contrary - many experts say Yellen and her crew should have taken the first step back in the direction of higher interest rates much earlier. The US economy is in a solid growth phase, and unemployment is down to 5 percent. When, if not now, should the central bank try to return to normality?

The near-zero interest rate that has been in place since not long after the global financial crisis (GFC) broke out in 2008 is not normal. What's normal is what used to be in place in past decades: An appropriate risk-adjusted return for savers and investors like pension or insurance funds that allows them to avoid a continual hunt for ever higher-risk investments in an effort to get more than a zero return.

Is the end of the world nigh?

Despite the modest and overdue nature of this tiny rate hike, many players on financial markets are now talking up doom scenarios. The interest rate turnaround, especially if it's done too fast, will jack up the value of the dollar, and thereby weaken the prospects for US exports on global markets, braking US GDP, the doomsayers claim.

Moreover, they add, the rate of inflation in the US, like that in the eurozone, is very low. Rising interest rates could generate a renewed risk of deflation. In addition, emerging economies around the world will suffer from massive capital outflows as the dollar strengthens along with the Fed's interest rate. In short: the global economy is once again at risk.

Those who make such arguments aren't necessarily pessimists. They may simply be investors who have become addicted to the Fed's policy drug of ultra-cheap money, and are no longer able to thrive without it. The reality is that the central bank's interest rate corridor has only been lifted from 0.00 - 0.25 percent to 0.25 - 0.50 percent, and financial markets have long anticipated the move - it has long been "priced in" to financial markets, in the jargon of the trade.

So even though today's interest rate turnaround may be "historic" in the context of nine years of near-zero interest rates not having been raised even once, in terms of the practical deals that take place between the Fed and the commercial banks - the overnight loans to which these core Fed interest rates apply - the rate hike will have scarcely any effect.

But maybe, in light of an expectation that rates will continue to gradually rise, this first modest move will begin to dampen the frantic hunt for returns and the trend toward speculative bubbles forming on the back of borrowed money.

DW's Rolf Wenkel

DW's Rolf Wenkel

Tiny steps

It's also worth noting that the Fed has already signaled that it takes the concerns of the pessimists seriously. Janet Yellen and her colleagues have repeatedly emphasized that the Fed's interest rate turnaround will be "gradual" and "data-driven."

This means that the Fed rate will be raised in small steps, not in big leaps, and any rate rises will only occur if the data on employment, wages and prices justify them.

All in all, this policy stance makes for an interest rate turnaround administered in homeopathic doses, which will neither put a brake on the robust US economy nor stomp on the delicate flower of recovery in Europe.

On the contrary - for Europe, an expected trend toward a stronger dollar should help European and Asian exporters, where a lot of business continues to be denominated in dollars.

Everyone had time to prepare

Only the emerging economies are faced with a real problem. Rolling over their dollar-denominated debts is about to get more expensive. That's less of a concern for China or India, but it's a real worry for heavily indebted Brazil.

Emerging economies were among those that profited from the Fed's long period of ultra-low interest rates, because they offered more attractive interest rates in their own currencies to American or other foreign investors. But now those investors will begin pulling out their money and putting it into American financial assets, and that could pose a risk to emerging economies' ability to finance some projects.

But here, too, it's true that the Fed has been signaling a rate hike for many months, so there was plenty of time for everyone to prepare - everyone including governments and investors in emerging economies. There was enough time to put in place reforms to increase investor confidence in the sanctity of contract law, for example, in order to reassure foreign investors. Much of the money that will flow out of emerging financial markets won't be flowing because of any dramatic rise in US interest rates - those aren't in the cards - but rather because country risk is much lower.

In a nutshell: The Fed's exit from its ultra-cheap money policy was way overdue. A lot of investors and politicians had got used to money being available almost for free. The sweet drug of cheap money weakened the political will to undertake reforms and anaesthetized investors' risk-sensing organs. It's high time for the world to return to normal monetary policy conditions.

And that return to normality should apply to the monetary policies of Mario Draghi's European Central Bank as well.

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