Could interest rates rise in the wake of a proposed Federal Reserve rule?

The Federal Reserve announced a proposed change to its forward guidance that could cause bond rates to rise in the United States sooner than expected.

Boston Federal Reserve President Eric Rosengren said that the Federal Reserve may choose to cease forward guidance on monetary policy for market participants, which would allow the central bank to raise the Federal Funds Rate from its historic low of 0.25%. That rate has remained unchanged since it was lowered after the global financial crisis in 2008-2009.

The Federal Reserve announced a proposed change to its forward guidance that could cause bond rates to rise in the United States sooner than expected.

Boston Federal Reserve President Eric Rosengren said that the Federal Reserve may choose to cease forward guidance on monetary policy for market participants, which would allow the central bank to raise the Federal Funds Rate from its historic low of 0.25%. That rate has remained unchanged since it was lowered after the global financial crisis in 2008-2009.

“As we approach levels of unemployment that many consider ‘full employment,’ the Fed should no longer issue guidance on the approximate timing of any monetary policy changes,” said Rosengren in a speech on September 5th.

While unemployment has fallen to 6.1% in the U.S., previous expectations of a rising interest rate environment on a strengthening labor market have subsided. Earlier, Janet Yellen has publicly said that the Fed will look for broader indications of a strengthening labor market before rising rates, adding that lower labor force participation and other indicators suggests that sufficient slack remains in the economy for rates to stay low.

U.S. equities fluctuated on the news Wednesday and in early market trading on Thursday, with bonds seeing the broadest increases in yields for 2014. The 10-year Treasury rose to 2.375% in Wednesday trading, still far below the highest point for the year hit in early January.

Greater Bank Costs

Banks may find it more expensive to hold greater reserves in the future as the Federal Reserve plans to change regulations that would encourage large banks to downsize or reduce certain operations. The move would require large banks to have capital ratios of 11.5% or higher, reducing these banks’ access to short-term funding.

The larger requirements for big banks would encourage banks to spin-off or sell certain operations, while also encouraging banks to sell stock and issue less short-term debt. 

The move could also encourage more lending to smaller businesses by forcing banks to specialize in more small-scale practices. Low interest rates have been in place for over five years to encourage more lending to small and mid-sized businesses, as well as to stimulate more lending for consumer spending. However, many analysts have argued that credit has remained far too tight since 2009, with many consumers complaining that banks will not lend to people with average or even good credit scores. Some economists believe that low rates have made banks risk averse, encouraging greater capital holding and perpetuating a credit crunch.

To combat this, Federal Reserve Board member Daniel Tarullo said the Fed would work on new rules that encouraged greater bank stability while also helping smaller banks to compete. “By further increasing the amount of the most loss-absorbing form of capital that is required to be held by firms that potentially pose the greatest risk to financial stability, we intend to improve the resiliency of these firms,” said Tarullo to Congress.