The Federal Reserve declared the U.S. monetary tightening cycle lives on as in fact it should. Of course, not everybody agrees with that.

The Fed’s decision to raise rates by 0.25 percent reflects a U.S. economy with good growth and at abnormally low “real” interest rates.

The Fed has signaled its intention to continue to address the abnormally low real interest rates with further rate increases next year. That would imply a March and a June rate hike, although the timing wasn’t spelled out.

This was coming from a double signal:

• The “famed” dot plots indicated, for now at least, 2 more rate hikes next year and
• Fed Chair Powell signaled that the famed dot plots were a signal to be taken seriously, which probably should reassure markets if the steady hike-pause, hike-pause rhythm that has dominated the tightening process were to be continued.

What was spelled out was the Fed’s belief in its independence from political interference.

The Fed Chair stated in the introduction to his press conference: “We will adjust monetary policy as best we can to keep the expansion on track, the labor market strong, and inflation near 2 percent. We know that our policy decisions affect all American families and businesses, and will continue to make our decisions objectively and based solely on the best information and analysis.”

That is something that should reassure financial markets. Undermining central bank independence would not be good news. 

Central banks generally are supposed to look at the economy as a “whole”.

Equity markets are an unrepresentative section of the economy as a whole and indeed are probably becoming increasingly unrepresentative of the economy as a whole.

Equity markets will continue to react more than the economy to, for example, trade tariffs or to moves in bond yields.

Wage increases and a falling profit share of GDP would be a negative for the equity market, but they are probably a positive for the economy as a whole.

To understand central banks, even central banks run by lawyers, it is best to look at the economy as a whole.

One point that the Fed did highlight is that while they are confident in “domestic” demand, they appear to be worried about “global” demand.

This has been a “common” theme globally.

When economists are asked anywhere in the world about the risks, they all say that it’s not their economy that’s the risk, but that they are worried about anyone else. Collectively that should be a positive sign as is no one is worried about the economies they understand best. The global economy should be OK next year.  

In this context, the FOMC statement reads: “The Committee will assess realized and expected economic conditions relative to its maximum employment objective and its symmetric 2 percent inflation objective. The Committee judges that risks to the economic outlook are roughly balanced, but will continue to monitor global economic and financial developments and assess their implications for the economic outlook.”

The dollar index DXY quotes below 97

Bank of Japan Leaves Interest Rates Unchanged

The Bank of Japan (BoJ) left today its key short-term interest rate unchanged at -0.1 percent, even after the Fed raised rates yesterday. The BoJ policymakers also kept the target for the 10-year government bond yield at around zero percent and maintained their upbeat view on the domestic economy.

Bank of Japan Governor Kuroda said at the press conference, according to Reuters: “It’s true investors’ risk-aversive stance is intensifying, causing some volatility in Japanese and overseas markets … But corporate profits, which serve as a basis for stock price moves, are strong in Japan, Europe and the United States … There’s no change to our baseline view on Japan’s economy and its outlook.”

Bank of England Holds the Bank Rate Unchanged

The Bank of England voted today unanimously to hold the Bank Rate at 0.75 percent, saying that Brexit uncertainty had “intensified considerably” over the last month while inflation is expected to ease below the 2 percent target soon amid falling oil prices.

The British pound is back below $1.27

The decision to drag out the interminable tedious divorce from the European Union (EU) creates enough economic uncertainty in the “real” world to delay what the bank would like to do, which is to probably raise rates a couple of times. 

The Bank of England is independent to political interference, but it’s not independent to the consequences of political decisions.

Etienne "Hans" Parisis is a bank economist who has advised investors on financial markets and international investments.