Market Moves Following Federal Reserve October Statement
James Mee comments on news of a potential Fed rate rise
The American Central Bank, the Federal Reserve (Fed), issued a statement following their monetary policy meeting on October 28th indicating that they are considering a rate rise at their next meeting in December 1.
The immediate reaction of the market was for interest rates to rise (the 2Y Treasury yield spiked by 7 basis points (from 0.6414% to 0.7157%) initially, while the S&P 500 dropped by 0.97% 2). Interestingly, however, the S&P reversed its immediate negative reaction, climbing back up by 1.29% and closing above where it sat pre-sell-off.
This is a strange reaction: higher interest rates would imply cheaper equities merely from a valuation perspective. However, the market appears to have read between the lines and seen a positive economic outlook: 'the Fed would not raise rates (or even indicate that it might) without good reason'.
Why Did the Fed Indicate they may Raise Rates?
In the Fed’s September Statement, Janet Yellen made the unusual comment that they are “monitoring developments abroad” as a partial justification for not raising interest rates. This was a complete reversal of the Fed’s general view that they are not the banker to the world, but rather focused on the US economy.
Fast forward a month, and China has eased monetary policy, the ECB has indicated that they can and may do more, and Japanese economic data continues to trail its own central bank’s inflation forecasts, implying at least the potential for further loosening of monetary policy.
Assuming the Fed is still "monitoring developments abroad" 3, such injections of liquidity (which are generally positive for economies and risk assets alike) will have eased some of the pressure on Governor Yellen to maintain "accommodative financial conditions" 4 in order to prop up global growth.
Given the relatively benign market moves following the announcement and expectations of further liquidity injections globally, the Fed may have a small window where it may raise interest rates. Assuming the US Dollar does not move appreciably against them, we may well see US interest rates begin their rising cycle before the year is out. If this is the case, expect bond market volatility: only 50% of market participants expect a rate rise in December .
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1 Federal Reserve Press Release, Oct 28th 2015
3 Federal Reserve Press Release, Sept 17 2015
4 Federal Reserve Press Release, Sept 17 2015