James Bevan: First thoughts on the Fed’s +0.25%
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Janet Yellan, head of US Federal Reserve. Image: IMF
The Federal Open Market Committee voted to raise the federal funds rate from near zero interest rate policy (NZIRP) to NZIRP+0.25.
That shouldn’t be such a big deal but NZIRP has been with us since December 16, 2008 and ever since the Fed terminated QE at the end of October 2014, there’s been rampant speculation as to when the first hike would take place.
In raising rates, Fed officials hope they won’t kill the economy and odds are that they won’t, but they will stress that the next rate hike won’t happen until they see how well the economy takes this one.
And yesterday morning before the rate decision was announced in the afternoon, US industrial production fell 0.6% during November, and we learned that Markit’s flash US M-PMI dropped to 51.3 during December, the lowest since October 2012.
Weighing on US manufacturing have been declines in oil production and output of energy capital goods. Yesterday, the price of a barrel of WTI crude oil dropped over 4%, nearing the lows of 2008.
Gradual adjustments
Not surprisingly, the word “gradual” appeared twice in yesterday’s FOMC statement to describe the pace of rate hikes in the future: “The Committee currently expects that, with gradual adjustments in the stance of monetary policy, economic activity will continue to expand at a moderate pace and labor market indicators will continue to strengthen. …
“The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run.”
It was always likely that assuming that the Fed did hike on 16th December, Mrs Yellen was going to stress during her press conference that the process of normalizing monetary policy will continue to be abnormally slow. Mrs Yellen used the word ‘gradual’ thirteen times all told.
Not surprisingly, stocks reacted positively to yesterday’s dovish statement and Mrs Yellen’s dovish press conference. The most optimistic now expect a strong rally towards year end.
Rally
The bad news has come essentially from the high yield markets and last Friday equities fell on news that Third Avenue Management LLC barred investors from withdrawals while it liquidates its high-yield bond fund.
Yesterday Bloomberg confirmed in an article titled Third Avenue Bled Managers, Assets Before Fund Shut Down that Third Avenue’s assets actually peaked back in 2006 at $26bn, sinking to $8bn at the end of November and this hedge fund’s challenges may be fairly unique.
If markets come to believe that the rate hike might be the last for a very long time, and that a rate cut isn’t out of the question in 2016, the dollar should peak and commodity prices should bottom. That could set the stage for another round of yield-reaching next year.
In this scenario, the yield spread between high-yield corporates and 10-year Treasuries, which widened significantly since the summer of 2014, might start to narrow again and the S&P 500 VIX should decline, clearing the way for a rally.
James Bevan
James Bevan is chief investment officer of CCLA, specialist fund manager for charities and the public sector. CCLA launched The Public Sector Deposit Fund in 2011 to meet the needs of local authorities and other public sector organisations. You can follow James on twitter @jamesbevan_ccla
* CCLA is a supporter of Room151
