Fed finally pulls the trigger

After a full year of waiting, the Federal Reserve finally raise benchmark rate by 25 basis point to 0.25 - 0.50%.

Fed
Source: Bloomberg

Despite less than ideal conditions to tighten policy, the FOMC decided unanimously to do so, for fear that they may be behind the curve if they dilly dally further.

Nonetheless, one may interpret the Fed’s decision as a reflection of their confidence that things will continue to get better. Chairperson Janet Yellen said, “Americans should realise that the Fed’s decision today reflects our confidence in the US economy. While things may be uneven across regions of the country and different industrial sectors, we see an economy that is on a path of sustainable improvement.”

Regardless, the US monetary policy remains accommodative after the increase, and the average expectations of the path of future rates stays the same. According to the dots plot chart, Fed policy makers projected an average rate of 1.375% by the end of 2016, same as in September, which implied four 25bps increases in the target range next year. In the last tightening cycle, which started in 2004, the Fed went on to raise interest rates 17 times within two years, from 1% to 5.25%, which means one 25bps increase at each FOMC meeting. This time round, it has been well publicised that the tightening is going to be gradual. There is a belief that the Fed may pick meetings with press conferences (March, June, September, December) to raise rates. I feel their decision will hinge more on data than anything else. In short, inflation needs to show sustained signs of a pick-up. Same goes for the labour markets.

Reaction in the financial markets was rather subdued. US equities rallied, while the dollar initially weakened. Treasury yields headed higher. The muted response was largely attributed to Yellen’s mastery at telegraphing the Fed’s intention to normalise rates by end of the year. I also sense the markets’ realisation that the rate hike, while symbolic, does not remove the accommodative conditions.

That said, energy prices were affected, but not really by FOMC, but by the EIA report, which corroborated with the API data, showing an increase in US crude inventories against market expectations.

 

Markets

  • US equities rallied on the back of FOMC decision to raise interest rates. S&P 500 gained 1.5% to close at 2073. The Dow Jones jumped 1.3%, ending at 17749.
  • The US yield curve continues to flatten, with short-dated treasuries falling faster than longer tenures. Benchmark 2-year and 10-year yields rose 4.1bps and 0.7bps to 1.005% and 2.273% respectively.
  • The greenback was mostly higher against the major currencies, with the dollar index heading towards 99. EUR/USD fell below 1.09; USD/JPY rose above 122. [currencies:USDCAD/USD/CAD] climbed to around 1.38, where the loonie is also hit by falling oil prices.
  • WTI pulled back below $36, although still below Monday lows of $34.53. Brent slipped towards $37. The Brent-WTI gap widened, after narrowing to as close as around 30 cents. Gold was lifted to above $1070.
  • PBOC cut their 2015 GDP forecast to 6.9%, and expects 2016 growth to come in at 6.8% as consumer inflation picks pace and the property market recovers. While it is without a doubt that there is a slowdown in China, the PBOC expects several supportive factors to accelerate next year to shore up growth, which includes macro and structural policies. Bloomberg survey is more pessimistic, with the consensus looking at a much slower 6.5% next year.

 

Asia should be energised by the strong performance on the Street, helped also by the removal of uncertainty after the Fed raise interest rates. Australia and Japan are already building on gains from the previous session. The rest of Asia may follow suit. For Singapore, the STI is eyeing an upside break of 2850, although the disappointing exports data may take the shine off the anticipated rally. USD/SGD was higher, trading past 1.41 this morning.

Singapore’s exports for November were much weaker than expected, as NODX surprised on the downside, contracting -3.3% y/y versus estimate of +1.5%, dragged primarily by non-electronics shipments, especially volatile pharmaceuticals. Electronics exports grew significantly slower at +0.7% against +5.2% forecast.

 

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