On Wednesday, at the Federal Open Market Committee (FOMC) Meeting, the Federal Reserve announced the most awaited increase in the benchmark federal funds rate after more than nine years. The interest rate was hiked to 0.25%-0.50% from zero since December 2008.
Notably, following the 2008 financial crisis and the Great Recession, which came to end in mid-2009, the FOMC decreased the rate to zero almost seven years ago on Dec 16, 2008.
"Given the economic outlook, and recognizing the time it takes for policy actions to affect future economic conditions, the committee decided to raise the target range for the federal funds rate to ¼ to ½ percent," the FOMC's post-meeting statement said. "The stance of monetary policy remains accommodative after this increase, thereby supporting further improvements in labor market conditions and a return to 2 percent inflation."
The Fed has been cautious due to the overall weak economic data in the second and third quarter of 2015. However, now with the moderate pace of economic growth, recent strong gains in the labor market, including an October jobs report that showed employers added 271,000 new positions, pushing unemployment down to 5% and inflation target expected to return to the Fed’s 2% target, rate hike is an added advantage.
Consumer discretionary, financial and technology are the sectors most affected by the prolonged lower interest rate scenario. Most financial entities like banks, insurance companies, brokerage firms and money managers will benefit from rising rates as margins expand.
The interest rates hike, though at a slower pace, will ease some pressure on net interest margin (NIM) – a key source of banks’ earnings. Also, banks will earn more from the money that they need to keep at the Fed compared with almost no income from this source in a near-zero rate environment that has prevailed since the last financial meltdown.
Therefore, following the interest rate hike announcement, most of the Wall Street biggies including Wells Fargo & Company WFC, The PNC Financial Services Group, Inc. PNC, Citigroup Inc. C and Bank of America Corporation BAC increased their prime lending rate to 3.50%, effective Dec 17, 2015.
Nonetheless, the rate-hiking cycle will be gradual and the frequency will depend on the performance of the U.S. economy. So the borrowing costs for consumers and businesses are not expected to extensively increase in the near term.
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