The U.S. Federal Reserve is widely expected to begin raising interest rates at its Dec. 16 meeting after multiple delays due to various concerns over the impact of a rate hike on the ecomoy.
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Although this would be the first rate hike since 2006, economists generally think raising rates will be a mistake if the Fed follows through.
What to expect when the Fed starts hiking rates
However, Deutsche Bank analysts believe it’s not a mistake and that the U.S. economy is now strong enough to be able to withstand higher rates. In their Dec. 9 report entitled “Fed: Taking the Plunge,” they outlined the reasons the Fed put off hiking rates in September and October:
They also explained their arguments for why the economy can handle a rate hike now:
So if the Fed does opt for a rate hike in a few days, just how quickly will regulators raise interest rates? It’s anyone’s guess, but likely the increases will come slowly while policymakers gauge whether higher interest rates are having a detrimental impact on the economy or if the economy is strong enough to handle them.
After coming gradually next year, Deutsche Bank believes the rate hikes will accelerate as the Fed sees that the impacts causing them to move slowly and cautiously begin to wane. The firm’s analysts actually believe that the market is only pricing in a “much more gradual ascent” in interest rates, a disconnect they expect to be fixed after a few rate hikes.
Expected market reactions to a Fed rate hike
Looking into the long term, they expect interest rates to peak at a lower level than they did in the past but “very likely higher than current market expectations.”
They believe that the rate hikes may be more during the first half of 2016 compared to the second half, and they expect inflation to begin slowing toward the middle of the year, especially if regulators start tapering their reinvestment policy. Deutsche Bank believes the combination of these factors will result in the Fed pausing “briefly” in the second half of next year. Because the markets are already pricing in a rate hike for this month, it’s unlikely that there will be much of a reaction.
“Beyond the first hike, the outlook for risk assets will be determined by how the disagreement between the market and the Fed about the pace and extent of hikes gets resolved,” Deutsche Bank analysts wrote. “Risk assets should be resilient in 2016 if this repricing is gradual and orderly,” they added.
All images in this article are courtesy Deutsche Bank.