by Harbour Asset Management
The market was expecting a so-called ‘dovish hike’ – for the Fed to lift the overnight interest rate, while emphasising that this will be a very timid tightening cycle with interest rates low for some time.
There was some initial surprise that the Fed had not significantly lowered its future forecasts for the Fed Funds Rate. These still sit around 1.40% for the end of 2016 (implying four hikes next year) and around 3.5% for its longer run assumption.
As it turned out, the dovish tone from the Fed came from the repeated emphasis within the press release on current US inflation remaining below target. The Fed noted that market measures of inflation expectations have fallen, that it is monitoring inflation very closely, and is only “reasonably confident” of inflation rising to target.
By clearly setting out that there is a risk that inflation will remain stubbornly low, the Fed has opened the door to delivering fewer rate hikes in 2016 should inflation not materialise.
The US Federal Reserve, ECB and RBNZ have all now made their policy announcements in December. If there were a prize for delivering a modest initial market reaction (or at least in the direction intended), the US Fed would be the clear winner on that metric. The US dollar and US Treasury yields are little changed following the announcement. In equities, the S&P 500 took comfort from the decision, ending up around 1.50% for the day.
Looking ahead, we believe the global monetary backdrop continues to be supportive for equity markets, including in New Zealand and Australia. The Fed has finally delivered clarity, and this allows the market to move its focus back to the fundamentals. In previous tightening cycles, equities have continued to perform, in part because of the improving growth outlook. It looks some time before sharply rising inflation creates a problem for equity markets; if anything the Fed emphasised the alternative scenario of stubbornly low inflation delaying the tightening cycle.
Finally, if Graeme Wheeler was hoping for a Christmas present from the Fed decision, it has not eventuated. The Governor has been very open about wanting the Fed to finally get on with it and raise the Fed Funds rate, in the hope this would weaken the NZ dollar. As it has turned out, since the RBNZ’s ‘hawkish cut’ last week, NZ bond yields have risen 0.15% and the NZ dollar is sitting around 5% above the RBNZ’s forecasts. This makes it harder for the RBNZ to get CPI inflation back to the 2% mid-point of its target range. In our view, that raises the chances of further OCR cuts in 2016.
Christian Hawkesby, Director, Head of Fixed Interest & Economics
This column does not constitute advice to any person.
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