The Federal Reserve of the United States, or simply the Fed, is one of the most proactive central banks in the world. Because it sets the monetary policy following the developments on the world’s largest economy and it supervises the world’s reserve currency, everything that the Fed does is quickly copied by other central banks in the developed world.
However, that is not always the case. According to the theory of the business cycle, even though developed countries may experience economic growth, their economies might be in different stages – early expansion, late expansion, boom, or even at the peak of the evening cycle. As such, not always when the Fed makes a move on the interest rates, the other central banks follow – but on average, they do.
The mega-consensus is that the Fed will leave the interest rates low for as long as possible – several years from now. Yet, the market has the tendency to put pressure on central banks, and it will not be the first time to put pressure on the Fed too.
Those old enough to remember the taper tantrum after the quantitative easing programs in the aftermath of the Great Financial Crisis of 2008-2009, the market selloff made the Fed change its mind. This time, at least one investment house bets that the Fed will hike the rates much earlier than forecast.
What May Trigger A Fed Hike?
Inflation is one thing. The Fed changed its mandate, and now it looks at average inflation to exceed 2%. While it is not clear the time horizon considered for the average, one thing is sure – the Fed will not hesitate hiking should inflation rise above target faster than anticipating.
Strong economic growth is another. Now that effective vaccines are rolled out, the expectations are that we will see a gradual pickup in economic growth in the months to come. That is expected to accelerate toward the end of the year, should the world manage to defeat the pandemic.
During the pandemic, the Fed lowered the rates to zero and engaged in massive easing. The fiscal stimulus also helped ease financial strains.
However, if the economy picks up faster than the Fed models predict, the rates will also rise faster. It would not be the first time when the Fed will be surprised, nor the last time.