Federal Reserve tightening expected to be shallow

THE US Federal Reserve is likely to raise interest rates for the first time in nine years at its next monetary decision-making meeting on Dec 15-16, but next year's tightening cycle is likely to be shallow. By December 2016 the Fed may have to start cutting rates again as the economic cycle weakens.

US rates have been near zero since December 2008. In view of expectations that a rate hike is close, the focus of financial markets has shifted towards predicting subsequent increases. The December 2016 Fed Funds futures is around 0.83 per cent, implying fewer than three hikes next year. In fact, the pace of tightening is likely to be lower than this.

After the December rise, the Fed is likely to make just one interest rate increase next year - in March. By June, uneven US growth and still-low inflation could persuade the Fed to pause tightening, with a cut possible at the end of 2016. The Fed is likely to continue to reinvest in government bonds and mortgage-backed securities, as its stock of debt acquired in previous bouts of quantitative easing matures. This should continue at least until 2018.1