Lifting rates from near zero will not be smooth

Interest rates Markets do not always obey the signals that come from the US Fed. Normalising rates could ripple in many different directions. 
 
A decade ago, the then-US Federal Reserve chairman, Alan Greenspan, announced a pre-emptive tightening of the official target interest rate. The Fed's action was designed to defuse a boom in the housing market.
 
The market response was immediate. Investors, as expected given the change in the target rate, built large, short-term positions in long-term debt securities. Yields on 10- year US Treasury bonds rose about 1 per cent over the ensuing weeks.
 
Then, as Greenspan relates in his autobiography The Age of Turbulence, market pressures – seemingly coming out of nowhere – drove down long-term rates. Greenspan records that he was "both perplexed and intrigued".
 
He wrote: "We had no reason to expect that a Fed tightening would not carry longterm rates up with it." Appearing before a congressional committee, he called the historically unprecedented state of affairs "a conundrum".
 
The initial June 2004 tightening was the first of 17 interest rate changes announced after successive meetings of the Federal Open Market Committee (FOMC).
 
The most memorable of those was on December 16, 2008, two months after the collapse of the investment bank Lehman Brothers, when the Fed set its interest rate target between 0 per cent and 0.25 per cent. That meant the target had effectively reached the lower-zero bound, below where it was when tightening began.
 
Unable to reduce interest rates any further, the Fed turned to quantitative easing (QE). This involved purchases of Treasuries and other financial assets such as mortgage-backed securities, and enabled the Fed to influence interest rates across a wide range of financial assets. It has now wound down its QE program and hopes to begin "normalising" monetary policy in about the middle of 2015.
 
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Max Walsh

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Max Walsh was for many years one of Australia’s top economic and political commentators, highly regarded as a journalist, author and broadcaster. Throughout his career, Max was involved in all dimensions of the media industry, which has encompassed positions with two of Australia’s largest publishing companies and television networks.

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