Yellen’s “tightening” promises a slow crawl higher

23 Dec 2015 | Author: | No comments yet »

Fed’s rate rise has shown America is strongUS stocks gained on Wednesday as the Fed raised interest rates to a range of 0.25 per cent to 0.5 per cent, as widely expected. Shares of Red Hat Inc. gained in Thursday’s extended session after the open-source software provider posted results that beat analysts’ expectations.U.S. stocks dropped Thursday on persistent concern over faltering global economic growth, led by declines in energy and materials shares, a day after shares had rallied on the Federal Reserve’s decision to raise interest rates.

Red Hat reported fiscal third-quarter earnings edged down to $46.9 million, or 25 cents a share, from $47.9 million, or 26 cents a share, a year earlier. Oil prices LCOc1 CLc1 extended recent declines on persistent oversupply worries and as the dollar .DXY hit a two-week high. [O/R] [FRX/] Dow components Exxon (XOM.N) and Chevron (CVX.N) were down, by 1.5 and 3.1 percent, respectively. Australia’s S&P/ASX 200 is down 1.4 per cent within the first half-hour of trade, while futures tip Japan’s Nikkei to climb 0.2 per cent and for Hong Kong’s Hang Seng to slide 0.1 per cent. After a more than 1% post Fed rate-hike rally on Wednesday, Wall Street gave back gains on Thursday as renewed pressure from the energy sector forced U.S. equity markets substantially lower. “With the U.S. dollar strengthening, the subsequent sell off in commodities was inevitable as further pressure has been brought to bear on energy prices along with both base and precious metals,” Alastair McCaig, IG market analyst wrote in note. The stock markets cheered the Fed rate hike, but some economists saw the central bank as acknowledging how little it knows about where the economy might be headed.

The Fed statement hedged the possibility that inflation might not pick up much and acknowledged that global pressures could influence its choices going forward, said Charles Calomiris, a professor of economics and finance at Columbia University. The FFR, for those not au fait with central bank parlance – and who is? – is the equivalent of the Bank of England base rate, which is the rate with which the Bank attempts to guide all other interest rates within the UK economy. The global headwinds stemming from difficulties in emerging economies such as China, Russia and Brazil could further suppress inflation and hurt hiring, possibilities that the Fed might struggle to model. “The Fed is much more uncertain itself about what is going on in the economy and willing to express that,” Calomiris said. “It doesn’t have a very clear model of how the economy is functioning.” Bank of America says it is increasing the prime lending rate to 3.5 percent effective immediately, while Citibank, M&T Bank and PNC Financial plan to make the change effective Thursday. Lower oil prices again weighed upon Wall Street, with Brent crude, the international benchmark, settling 0.9 per cent weaker at $37.06 a barrel after trading as low as $36.81 and reapproaching Monday’s seven-year low of $36.33. The only difference between the two – other than the names – is that the base rate is a single number, a target if you will, whereas the FFR is two numbers, a range.

Investors’ focus returned on Thursday, however, to concerns about weak global economic conditions as the slide in commodity markets continued unabated. China’s slowdown has been transmitted to the rest of the world through a fall in oil and commodities prices, said Hugh Johnson, chief investment officer of Hugh Johnson Advisors LLC in Albany, N.Y., which he said “is raising serious questions about global demand and the global economy.” The Dow Jones industrial average .DJI fell 253.25 points, or 1.43 percent, to 17,495.84, the S&P 500 .SPX lost 31.18 points, or 1.5 percent, to 2,041.89 and the Nasdaq Composite .IXIC dropped 68.58 points, or 1.35 percent, to 5,002.55.

The Fed’s decision on Wednesday to increase the rate was well flagged, thanks to guidance by chairman Janet Yellen and some of the other 11 members of the Federal Open Markets Committee. Economists at Goldman Sachs, in a note, said the Fed’s policy changes held very few surprises for Wall Street, and that’s partially why a blockbuster rally is unexpected in the days following the announcement. “The market reaction was limited, suggesting the policy and statement together were reasonably close to investor expectations. Post-meeting rates in the overnight indexed swap market suggest investors expect the effective funds rate to settle at around 0.34% after liftoff, up from 0.15% in recent days,” the note said.

Friday’s “quadruple-witching,” when options on stocks and indexes and futures on indexes and single stocks all expire on the same day, could exacerbate volatility. Declining issues outnumbered advancing ones on the NYSE by 2,016 to 1,048, for a 1.92-to-1 ratio on the downside; on the Nasdaq, 1,884 issues fell and 962 advanced for a 1.96-to-1 ratio favoring decliners. There isn’t a 100% consensus about what will happen next.” Though the first hike has come and gone, economic data will continue to play an important role in the Fed’s decision-making process moving forward as it expects to make three to four more increases before the end of next year. “I’m surprised that the markets are doing so well considering the Fed expects at least four more hikes in 2016,” Doty said. “I wonder if people just don’t believe that. About 8.0 billion shares changed hands on U.S. exchanges, compared with the 7.2 billion daily average for the past 20 trading days, according to Thomson Reuters data. On Thursday, the Philadelphia Federal Reserve’s gauge of manufacturing activity for the mid-Atlantic region dropped solidly back into contraction territory as it tumbled to -5.9 from 1.9 the month prior.

Having not moved rates for seven years – and not done so in an upward direction for nine years – even the act of placing those marks on the so-called “dot plot” would have felt historic for the 12 men and women involved. Meanwhile, the number of Americans filing for first-time unemployment benefits fell more than expected last week to 271,000 from an unrevised 282,000 the week prior. Expectations were for 275,000. “In light of the firming of job growth since the October meeting, the [policy] statement significantly upgraded its assessment of labor market developments.

It now notes ‘ongoing job gains’ and ‘declining unemployment,’ and says that underutilization of labor resources has diminished ‘appreciably,’” Goldman’s note continued. But the bigger impact, and the one which should concern those in the broader market, is the fact that the US will now become a more attractive place to deposit money. One of the triggers that led to the recent emerging market bubble – a bubble which is now rapidly deflating – was the flow of money from advanced economies looking to earn better rates of return. With many of those countries now experiencing real problems – Brazil, Argentina and Russia being just three examples – US fund managers could be forgiven for keeping their investments closer to home. Thirdly, the events of the past 36 hours have marked Yellen out, for those who were not already convinced, as a true leader, and worthy of controlling the 102-year-old institution.

But be forewarned: Fed forecasts about economic growth have been notoriously inaccurate during the more than six-year recovery from the Great Recession. He then used a speech at Lincoln Cathedral over the summer to suggest rates would rise at the turn of the year, only to backtrack, and suggest as recently as this week in a newspaper interview that the Fed’s increase would not mean that the UK will follow suit. Markets are bracing for news about whether the U.S. central bank will raise rates for the first time in nearly a decade — and the path of possible rate hikes in the year ahead.

This is a crucial sign that the rising inflation Fed officials expect to see might remain elusive, as cheaper oil undercuts the economy’s ability to achieve the Fed’s 2 percent target. The increases came despite the news that U.S. industrial output fell for the third straight month in November, another sign that American manufacturers are under stress. Though some in the markets question the ability of the U.S. economy to withstand higher U.S. interest rates, there is relief that the uncertainty over the Fed’s intentions is coming to an end. “Whether this optimism turns into a full blown Santa rally or not will depend on the Fed’s ability to manage expectations and reassure investors than the tightening cycle will be very gradual,” said Craig Erlam, senior market analyst at OANDA in London. Most Asian stock markets are finishing with big gains as anticipation builds for the Fed’s decision on whether to raise rates after seven years at ultralow levels. Hong Kong’s Hang Seng rebounded from a nine-day losing streak to advance 2 percent but gains were less robust on the Shanghai Composite Index in mainland China, which closed 0.2 percent higher.

Tara Sinclair, a professor at George Washington University and chief economist at the jobs site Indeed, says hiring in both industries would likely be influenced by how quickly the Fed raises rates over the next year. Higher borrowing costs could limit construction, and higher rates could also cause the dollar to rise, making U.S. manufacturing exports more expensive abroad. Some experts say higher American interest rates could increase capital outflows from China, put downward pressure on the yuan and complicate Beijing’s efforts to avoid a sharp economic slowdown. Wright says “the potential for normalization of U.S. monetary policy should definitely be seen as a headwind for Chinese attempts to ease monetary conditions.” Low interest rates have been a boon for stock market investors for several years but Fed officials have telegraphed the likely decision far in advance.

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