Interest rate markets functioning smoothly on day one after Fed hike

The decision by the US central bank to hike its main policy rate appeared to be having its intended effect on short-term market interest rates, soothing worries regarding the effectiveness of the Fed´s policy levers in the post-QE world.

One day after the FOMC increased the range for the Fed funds rate by 25 basis points to between 0.25% and 0.50%, the London Interbank Offered Rate - the rate at which banks lend to each other on an overnight basis - appeared to be mimicking the move smoothly.

LIBOR fixed at 0.3614% on Thursday morning in New York, up from 0.1315% a week earlier.

Despite the good news, some market watchers cautioned that Janet Yellen&Co. had not yet bought into the Fed´s so-called dot-plot graphs.

Whereas rate-setters in Washington DC said they anticipated - on a median basis - four 25 basis point interest rate increases for next year, financial markets were only pricing in two hikes.

"In order to align market expectations with its own it will have to be much more persuasive in its communication that it is serious about this hiking cycle. This in turn will lead to a tightening of financial conditions which the Fed will have to swallow if it is to hike.

"Our view is that there is a risk the Fed will struggle to hike rates as fast as its latest dots imply. We think this hiking cycle will be slow and at risk of pause and potential reversal for the reasons discussed above. Any uncertainty on the Fed's path could spell more volatility for US credit next year, as it did last September," Alberto Gallo, head of macro strategy at RBS, said in a research report sent to clients.