Janet Yellen appears to have pulled off the first interest rate increase in nine years without a hitch, despite a number of potential obstacles.
The interest rate targeted by the Fed traded at 0.37 percent Thursday, the first day of the Fed’s new higher target, the Federal Reserve Bank of New York reported Friday. That is nearly exactly in the middle of the 0.25 percent to 0.50 percent the Fed set Wednesday.
Movements in stock markets were relatively mild through Thursday, as were changes in the dollar and commodities.
Not only was Thursday the first day in the last nine years of short-term rates above zero, it was the first time the Fed had to rely on new tools for raising rates.
One of the challenges the Fed faces is the massive amounts of excess reserves in the market it usually trades in to move rates. Before 2008, banks held only the bare minimum of reserves at the Fed. After the central bank began paying interest rates on excess reserves, however, that number exploded to $2.5 trillion. With that massive sum potentially available to trade in markets, the Fed cannot guarantee that it could target a specific low rate.
To address that problem, the Fed raised the interest rate it pays on reserves from 0.25 percent to 0.50 percent. It also used another new tool to raise another rate, the rate on overnight reverse repurchase agreements from 0.05 percent to 0.25 percent. It engaged in $105 billion of reverse repurchases on Thursday.
Aside from the technical challenges related to raising rates, the Fed also faced a communications challenge. In 2013, the mere suggestion from then Fed Chairman Ben Bernanke that the central bank might slow its massive bond purchasing program led to turbulence in markets for Treasury securities and mortgages, an episode now known as the “Taper Tantrum.”
Markets this time around, however, had apparently fully anticipated and priced in the impact of the small rate hike, despite some predictions from economists that there inevitably would be volatility.
On Wednesday, Yellen said she was “confident that the normalization process will proceed smoothly.”
The central bank’s chairwoman added, however, that Fed officials “will be monitoring financial market developments closely in the coming days, and are prepared to make adjustments to our tools if that proves necessary.”
