There are varying views on what the latest rate rise says about the Fed's thinking on domestic economics, the timing of further increases and the effect on global markets.

The US Federal Reserve increased the benchmark interest rate to 2.25 per cent overnight, up 25 basis points from 2 per cent, as it forecasts at least three more years of economic growth.

In a move that was widely anticipated, the increase continues the Fed's tightening of the lending rate and further highlights the end of "accommodative" monetary policy.

The US central bank still foresees another rate hike in December, three more next year, and one increase in 2020.

The latest rise highlights the Fed's belief the economy will grow at a faster-than-expected 3.1 per cent this year, and continue to expand moderately for at least three more years. This growth is accompanied by sustained low unemployment, and stable inflation near its 2 per cent target.

Some commentators focused on US Federal Reserve chairman Jerome Powell's removal of the word "accommodative" from the monetary policy documentation, as proof of a broader structural shift.

"It does seem to potentially indicate they believe monetary policy is becoming less accommodative and getting more towards that neutral rate," Michael Arone, chief investment strategist at State Street Global Advisers, told AAP.

Morningstar US equity analyst Eric Compton also notes this shift in semantics by the Federal Open Market Committee.

"This suggests … it is getting closer to what it views as a neutral rate in the current environment, and may not be certain they are still being accommodative even as the market still expects many more rate hikes."

While this may change Morningstar's medium-term rate forecasts, "our long-term rate projection remains intact," Compton says.

In the US financials sector, he expects overall net interest margins to increase at a reduced pace regardless, as competition picks up among banks. "Therefore, we are leaving current fair value estimates in place for all of our banks," he says.

fed cash rate interest rates global economy

The Fed foresees another rate hike in December, three more next year, and one in 2020

Unsurprisingly, Wednesday's rate increase drew further criticism from President Donald Trump, who has complained that the Fed's actions are countering his efforts to boost the economy.

"We're doing great as a country. Unfortunately, they just raised interest rates because we are doing so well. I'm not happy about that," Trump told a press conference on the sidelines of the United Nations General Assembly in New York.

"I'd rather pay down debt or do other things, create more jobs. So, I'm worried about the fact that they seem to like raising interest rates."

Powell said the FOMC would remain independent and "[did not] consider political factors or things like that".

Emerging markets to bear the brunt: Fidelity

Fidelity International global economist Anna expects tightening of broader financial conditions means the Fed "will have to be more cautious in its rate rise cycle next year".

She highlights the potential effect on emerging markets, suggesting the tightening may prove "too much for the rest of the world".

"Emerging market economies, in particular, have already been facing tighter financial conditions this year, which have resurfaced some vulnerabilities as capital flows started reversing,” Stupnytska says.

"With the trade war rhetoric unlikely to de-escalate any time soon, the overall risks to US and global growth are clearly skewed to the downside. This means the Fed will have to strike a more cautious tone, slowing the pace of tightening next year, but we are not there yet," she says.

Further market volatility ahead: Charles Schwab

Lachlan McPherson, senior investment consultant at Charles Schwab Australia, says this rate hike again demonstrates the Fed's faith that it can continue to raise rates gradually, without slowing economic growth.

"While trade concerns are present, they are so far being counter-balanced by wage inflation, jobs gains and a multi-decade low in US unemployment claims.

"Average hourly earnings rose 2.9 per cent year-over-year as of August's jobs report, up from an average of 2.5 per cent last year. Relative to history, wage growth does not suggest over-heating, indicating that the Fed has little intention of crimping economic growth.

"A December hike seems almost certain, but that likelihood could ebb and flow depending on incoming economic data between now and then.

"We are only now getting to a positive real rate on the short end of the curve, so investors can continue to enjoy financial conditions which are still fairly loose, but – as the labour market remains tight and the Fed continues to shrink its balance sheet – inflation could pick up further from here, causing some volatility to return to markets," he says.

The Fed's latest projections show the economy continuing at a steady pace through 2019, with GDP growth seen at 2.5 per cent next year before slowing to 2.0 per cent in 2020 and to 1.8 per cent in 2021, as the impact of recent tax cuts and government spending fade.

Inflation was forecast to hover near 2 per cent over the next three years, while the unemployment rate is expected to fall to 3.5 per cent next year and remain there through 2020 before rising slightly in 2021.

The US jobless rate is currently 3.9 per cent.

Risks to the current run of economic growth, such as the threat of a damaging round of global tariff increases, were largely set aside.


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Glenn Freeman is senior editor, Morningstar Australia

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