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Why The Federal Reserve Chose Not To Raise Interest Rates In September 2016

The Federal Reserve is the US’s central bank and it is in charge of setting benchmark interest rates in the country. For investors here in Singapore, it could be useful to keep an eye on changes to the interest rate environment in the US since what happens there has a strong influence on what happens here.

In a previous article of mine, I wrote about the Fed’s decision to hold interest rates steady last month when it held its policy meeting. In the article, I mentioned that the Fed had decided against an interest rate hike because it wanted to “wait for further evidence of continued progress toward its objectives.”

With the release of the minutes of the September 2016 meeting last week, we now finally have more details on how the Fed came to its decision.

Doubts about economic growth

The minutes showed that the Fed’s staff had forecasted US economic growth in the second-half of 2016 to be better than the first-half of the year.

Their view was based on a strong labor market, industrial expansion, and personal consumption growth even as the housing market had weakened slightly since July 2016. But, the Fed was also worried that its forecast might be wrong. Here’s a quote from the meeting minutes:

“The risks to the forecast for real GDP were seen as tilted to the downside, reflecting the staff’s assessment that both monetary and fiscal policy appeared to be better posi-tioned to offset large positive shocks than adverse ones.”

The quote shows that the Fed wanted to err on the side of caution and assume that the economy would not be improving as they expect.

Giving more room for the labour market to improve and a lack of inflation

The Fed also kept a close eye on the US labour market. The leaders of the Fed who were present at the September meeting agreed that there had been strong improvement in the labour market as seen in solid payroll gains. But, some of them argued that there are areas of weakness such as weak wage growth. They added:

“This view suggested that proceeding cautiously with reducing monetary policy accommodation could promote further labor market improvement.”

Then, there was also a lack of inflation which added weight to the case for caution.

A Foolish summary

In the Fed’s September meeting, of the 10 leaders who had voting power on monetary policy, only three members insisted on having rate hikes in September.

That said, it was a close decision for some members who voted to hold rates steady. If there is sustained improvement in the US economy and further improvement in wage growth and the labour market, these factors could increase the odds of a rate hike by the Fed in its next policy meeting in a few months’ time.

In Singapore’s stock market, banks such as Oversea-Chinese Banking Corp Limited (SGX: O39) depend on net interest income for a substantial portion of its revenue. This net interest income in turn depends on a bank’s net interest margin, which is affected by the prevailing interest rate environment.

As already mentioned, Singapore’s interest rate environment is largely influenced by the Fed. If the US hikes rates, interest rates here could follow. My colleague David Kuo had recently wrote that the net interest margin for banks in Singapore could benefit from higher interest rates.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Ong Kai Kiat doesn't own shares in any companies mentioned.