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Yellen gives clearest indication to date that rate hike maybe near

The Chair of the Federal Reserve, Janet Yellen yesterday gave the clearest indication yet that a rise in US dollar interest rates is near.  Yellen said she was “looking forward” to the first rate hike, as it would signal that the US economic recovery was strong enough to be able to withstand non-zero interest rates.  Delaying the first rate rise further could have negative implications, according to Yellen.

The Fed Chair therefore tried to give a positive interpretation of the rate hike and prepare the markets to be ready for it.  There was again an effort to put the emphasis on the (potentially gently rising) interest rate path following the first hike rather than the date of the increase.  Interest rate hikes are likely to be gradual and it could take years until interest rates were normalized.  Inflation was expected to recover next year from its current low level as the effect of lower energy prices tapers off and the global economy picks up a little from this year.

One interesting point was that there are probably going to be dissenters as Yellen said such an outcome was nothing unusual.  It would be better for Yellen if such a historic decision to raise interest rates would be unanimous, but that might not be possible.  That could result in some confusing communication, as was the case following the September meeting with different Governors and board members having widely different views.

Other Fed officials speaking yesterday also echoed the sentiment that rates will rise at the December 15/16 meeting.  Probably strongest was the statement by Dennis Lockhart, President of the Atlanta Fed, that the case for a rate rise was “compelling” and that incoming data would have to “drastically alter” the economic outlook for a rate hike not to take place.

In this way, even ahead of this week’s nonfarm payrolls, most Fed Governors and officials (including the President, Janet Yellen) are on the side calling for a rate hike.  Still the markets are placing only around a 70% probability for a rate hike, which might appear odd.

In the wake of Yellen’s remarks the US dollar rose to a fresh 12 ½ -year high at 100.5, as the comments were surprisingly hawkish – at least for some market participants.  The focus now is increasingly shifting towards the pace of additional rate hikes rather than what will happen in the December meeting, with most analysts expecting 2-3 hikes next year, which would translate to an interest rate around 1-1.25% by the end of the year 2016.

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