Countdown to first Fed hike in a year under way, but focus shifting to 2017

Reuters London | Updated on January 16, 2018 Published on December 14, 2016


World stocks nudged lower, bond yields fell and a hush settled on the dollar, with investors certain the Federal Reserve will lift interest rates for the first time in a year on Wednesday but less so about what it may do in 2017.

European shares lost 0.3 per cent in early trade, while US stock futures were also a tad weaker, suggesting a cautious start to trade after Tuesday’s stock market rally to new all-time highs.

Asian stocks outside Japan eked out just a 0.1 per cent gain, while benchmark indices in Japan and China dithered either side of flat with investors reluctant to push shares much higher before the Fed meeting.

The Fed is widely tipped to lift rates 25 basis points to0.50-0.75 per cent when it concludes a two-day policy meeting on Wednesday. Its rate announcement is due at 1900 GMT, followed by Chair Janet Yellen’s news conference 30 minutes later.

It would be the Fed’s first interest rate hike in a year and its second since the financial crisis.

With a rise fully priced in by markets, eyes are on the Fed’s economic and rate “dot plots” for a sense of how policymakers think President-elect Donald Trump’s policies will impact growth and inflation.

“Last year the Fed guided the markets to expect at least four rate rises this year, guidance that proved to be woefully wide of the mark, and it is likely that they won’t want to make the same mistake again,” said Michael Hewson, chief market analyst at CMC Markets.

“That suggests that Fed chief Janet Yellen can expect some serious cross-examination of how the FOMC view not only the economy, but also President elect Donald Trump’s plans for it.”

For others, Yellen’s challenge is how to signal further rate increases without triggering strong gains in the dollar that could undermine growth.

The dollar index, which measures the greenback against a basket of six major currencies, hit 14-year peaks last month on expectations for higher inflation and interest rates.

The euro traded at $1.0613 on Wednesday, not far from the recent 20-month trough at $1.0505. The dollar was likewise steady on the yen at 115.12, while the dollar index was little changed at 101.02.

“Janet Yellen is in a corner for the December meeting,” said Nicolas Forest, global head of fixed income at CandriamInvestors Group.

“She has to hike interest rates but the dollar is strong, so she has to decide between a dovish and a hawkishhike.”

US yields lower

Treasuries have already priced in a rate hike and more, with10-year yields pulling back from peaks seen earlier this week just above 2.5 per cent.

In contrast to the Fed, the European Central Bank had only last week extended its asset-buying campaign and moved to purchase more short-term debt.

As a result, the spread between US and German two-year yields is at its widest since late 2005, with Treasuries offering a mouth-watering premium of 191 basis points.

Speculation that a Trump administration will implement more debt-financed fiscal stimulus and cut regulation helped all three major US stock indexes to record highs this week. The Dow ended fewer than 100 points from the 20,000 mark.

Bank of America Merrill Lynch’s latest survey of investors found expectations of global growth at 19-month highs and inflation at the second highest percentage in 12 years.

Fund managers were their most optimistic about corporate profits in more than six years and allocations to bank stocks surged to an all-time peak.

Bulk commodities from iron ore to coal have also benefited from the reflation trade, combined with signs of stronger growth in China. Again, any hint the Fed might step up the pace of tightening could undo some of those gains.

Oil ran into profit-taking following a reported rise in US crude inventories and an estimate that OPEC may have produced more crude in November than previously thought.

US crude futures, which hit a high of $53.41 on Tuesday, were down 60 cents at $52.38 a barrel. Brent crude eased 23 cents to $55.20.

Published on December 14, 2016
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