Fed Raise Sees Equities Gain

Market Trends - 17/12/2015

The Federal Open Market Committee made the decision Wednesday to raise the key interest rate for the first time in the last decade, initiating a process of monetary normalization and ending speculation over the future of policy. The Federal Reserves’ near zero interest rate of 0.25% imposed at the end of 2008, was raised by 25 basis points to 0.50% after a decision from FOMC voting members following the two day board meeting. The decision to raise rates is not without any risks though. Inflation is still far from policymakers’ desired target of 2.00% with weaker energy prices and a stronger dollar weighing on the outlook.  According to the latest revised projections, PCE inflation is expected to trend comfortably at 2.00% by 2018. The immediate impact for consumers will be virtually unnoticeable. Longer-term interest rates are unlikely to move very much according to Federal Reserve Chair Janet Yellen especially because there are no plans to sell off assets accumulated during quantitative easing. She reiterated her upbeat view remarking that, “Americans should realize that the FED’s decision reflects our confidence in the US economy.”

The decision left many market participants confused by the lack of reaction in financial instruments.  The dollar barely budged on the hawkish shift and equities surprisingly bounced even though the opposite was expected.  In all, the US dollar has improved since the announcement, gaining versus major peers while precious metals prices have slipped gradually on a less uncertain outlook for policy.  According to the projections, 4 rate hikes are expected in 2016 as rates reach towards 1.40%, meaning the US dollar rally might be in its early phase versus peers as the outlook for other advanced economies remains sluggish.  Although this marks the end of extremely loose policy conditions, the Federal Reserve announced no new measures to pare back the size of the balance sheet which experienced tremendous expansion during the quantitative easing experiment.  At present, the Central Bank has approximately $4,450,000,000,000 in assets with interest and principal proceeds reinvested.  As the dollar rises and the Fed moves to reduce the balance sheet, this will likely weigh on the outlook for US equity benchmarks in spite of the brief rally immediately following yesterday’s decision.


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