Why Hurricanes Won't Force the Fed to Ditch a December Rate Hike
Damage from Hurricanes Harvey (above) and Irma probably won't block a December interest-rate hike.

Anyone who saw New Orleans, in person or in pictures, after Hurricane Katrina's landfall in 2005 is unlikely to forget the sheer scale of its devastation. More than 80% of the city -- an area seven times the size of Manhattan -- was left underwater.

What many are less likely to recall is that Katrina's damage didn't stop the Federal Reserve from raising interest rates 25 basis points at its very next meeting, less than three weeks after the storm struck.

It's a precedent with particular relevance now, as the U.S. funnels aid to Texas and Florida in the wake of Hurricanes Harvey and Irma at the same time that the central bank signals that it's likely to go ahead with its third increase to short-term rates this year. The move, part of a broader shift away from the easy-money policies established to buoy the U.S. economy after the 2008 financial crisis, shows policymakers' confidence that the immediate impact of the storms won't be long-lasting.

While expansion will probably be held down for the rest of this year by the severe disruptions from the storms -- as well as Hurricane Maria, which hammered Puerto Rico this week -- growth will likely bounce back "as activity resumes and rebuilding gets under way," Fed Chair Janet Yellen said in a news conference this week.

Probable weakness in September payroll data and higher gas prices after Harvey shuttered refineries are expected to skew the incoming data the monetary policy committee would ordinarily rely on as it evaluates progress toward its goals of maximum employment and stable growth, but "such effects should unwind relatively quickly," Yellen said. "Based on past experience, these effects are unlikely to materially alter the course of the national economy beyond the next couple of quarters."

Basically, the central bank is indicating that monetary policy committee members won't allow "the recent weak growth data, which owes to the hurricanes, to influence their views around policy," Michelle Meyer, a U.S. economist with Bank of America Corp. (BAC) said in a note to clients. That "means market participants should also look past the noise in the data," she said.

Indeed, the Fed appears not only to be poised for a December hike that would take short term rates to a range of 1.25% to 1.5% but three more increases in 2018, Morgan Stanley Ellen Zentner said in a note to clients. Those could push rates to a range of 2% to 2.25% by next September, after which the central bank would probably pause to assess the results and determine if more adjustments were needed, she said.

The likelihood of further hikes is good news for banks from JPMorgan Chase & Co. (JPM) to Citigroup Inc. (C) , which typically boost margins by passing increases on to borrowers more quickly than to the depositors whose money is used to fund loans.

The lenders, which have benefited as the central bank slowly boosted rates since late 2015, could have seen growth crimped if the Fed paused increases as it starts to trim a balance sheet that ballooned to $4.5 trillion with investments intended to boost liquidity after the crisis.

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That initiative, which the central bank will start next month, is likely to continue uninterrupted, albeit slowly, barring a major economic shock that forces policymakers to return rates to nearly zero, Yellen said on Wednesday, Sept. 20.

Rather than sell any of the government debt and mortgage-backed securities purchased as unemployment surged to 10% and stock markets tumbled in 2008 and 2009, the Fed is paring the amount of proceeds from maturing securities that it reinvests each month. The rolloff will be capped at $10 billion a month initially, and the limit will be raised by the same amount every three months until it reaches $50 billion, the central bank said on Wednesday, Sept. 20.

Goldman Sachs Group Inc. (GS) and Barclays Plcs have both projected the Fed will ultimately trim its balance sheet by only about $1 trillion, a view shared by Bank of America (BAC) .

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