A small step for the US Fed but a big one towards normalcy

American flags wave on the exterior of the New York Stock Exchange (NYSE) in New York.
American flags wave on the exterior of the New York Stock Exchange (NYSE) in New York.PHOTO: BLOOMBERG

SINGAPORE - On early Thursday morning, the US Federal Reserve raised interest rates for the first time in nearly a decade, a move that had been anticipated for months, if not years.

By most accounts, it was a small step, a mere moving of the needle by just 0.25 of a percentage point.

More than that, Fed chair Janet Yellen and her band of economic governors signalled that they will continue to move cautiously over future rate hikes.

"In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realised and expected economic conditions relative to its objectives of maximum employment and 2 percent inflation," said the Federal Open Market Committee, which sets monetary policy for the US.

It noted that inflation was still below the 2 per cent objective but blamed it on low energy and import prices.

The language used implies that Fed is unlikely to move ahead quickly with further rate hikes.

Some analysts expect that rate rates could only hit 3 per cent by 2019, another four years from now.

Markets both in US and Asia rallied over the 'dovish' language used by the Fed to describe future rate hikes.

But while the market remains in celebratory mood, there is no doubt about one thing: The move, however small, heralded a real change in direction.

For about seven years, central banks supplied the economic system with near endless amounts of liquidity, which have helped the world avert another Great Depression, after the financial crisis in 2008.

The policy did its job well enough but the side-effects are only now beginning to show.

The clearest example is in emerging markets, where many corporations and individuals have taken on too much debt, as they took advantage of the record low interest rates. Weak economic growth is putting a strain on many of these firms to repay their debt.

According to the Institute of International Finance, next year almost US$600 billion of debt held by emerging market non-financial companies is due. Half of that is up for refinancing.

The record low rates have also punished savers, with bank deposits giving negative real rates, and forcing otherwise conservative individuals to head towards risky assets to maintain their purchasing power.

Inflation remains a spectre. So far, it has been weak but a sudden surge of inflation, due to the huge amounts of cash that continue to float in the system, is a concern that no one can ignore.

These will only add further risks to the global financial system which, if un-addressed, could result in another crisis.

To be sure, raising rates while could pose risks to the fragile global economy.

Other central banks in Japan, Europe and China have retained loose monetary policies because of these growth concerns.

But at some point these banks will also have to cut back. There is plenty of printing of money that can be done but the well is not bottomless.

To that end, the US Fed's rate hike on Thursday is a strong a signal that things need to go back to normal.

The path back to normalcy may be a long one, but the first small step is always the biggest.