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Tags: federal reserve | interest rates | janet yellen | stock market

Fed Taking it Slow, Giving Markets a Reason to Hit the Accelerator

Wednesday, 18 March 2015 05:51 PM EDT

If the opposite of a tantrum is a happy dance, then that's just what stock and bond markets performed on Wednesday after the Federal Reserve sounded less likely to act aggressively in raising interest rates than investors anticipated.

Although the Fed removed a reference to being "patient" on rates from the statement it issued after its policy meeting, it reduced its forecast for the path of the federal funds rate and economic growth. This drove rallies in both stocks and bonds as investors suggested the economy has a "Goldilocks" quality - not too hot, not too cold.

The Fed's stance puts it more in line with traders in short-term interest rate futures, who have long been skeptical that the Fed would try to raise rates as early as at its June policy-setting meeting. It also dovetails with recent statements from notable investors Ray Dalio of Bridgewater Associates and DoubleLine Capital's Jeffrey Gundlach, both of whom had urged the Fed to move cautiously.

"There has been a disconnect between the Fed and the markets and now the Fed has aligned itself with the market a little more," said John Derrick, director of research at U.S. Global Investors in San Antonio, Texas. "That changes the trajectory and pace people thought the Fed would follow."

The S&P 500 gained 1.5 percent from the level it was at before the Fed issued its statement and Treasury bonds rallied. The yield on the 10-year Treasury note dropped to its lowest level in nearly three weeks and the 2-year yield, seen as the most sensitive to market expectations of Fed policy movements, had its biggest one-day drop in six years.

The market's reaction contrasted with the "taper tantrum" of 2013, when markets swooned after then chairman Ben Bernanke surprised markets by indicating that the central bank was more open to tapering its monetary policy support.

Any Fed decision to remove monetary support is now anticipated to come later rather than sooner. Traders now give October a 58 percent of an interest-rate increase; September's odds have dropped to 38 percent from 61 percent prior to the meeting, according to CME FedWatch.

According to the Fed's forecasts issued on Wednesday, the central bank's median projection for the federal funds rate at the end of 2015 is 0.625 percent, compared with December's projection of 1.125 percent. The Fed's expectations for U.S. gross domestic product were also lowered.

The trajectory from here for bonds and stocks is uncertain.

Futures positioning shows traders had been aggressively building short positions in long-dated Treasuries, but non-commercial traders in two-year and five-year futures were net long, expecting lower short-term rates.

However, expectations for near-term rate increases meant a number of strategists had suggested short rates would rise, not fall, thus causing a "flattening," or a narrowing in the spread between long- and short-dated notes.

That may not happen now, as some strategists keyed in on the Fed's statement that it needs to see more improvement in the labor market before raising rates - when job growth has been one of the stronger facets of the economy of late.

"What's really significant is that they downgraded their assessment of the economy, and that means rates will stay lower for longer. And when they do start to rise, they will go at a much more muted pace," said Mary Ann Hurley, fixed income trader at D.A. Davidson in Seattle.

Investors in the equity market reacted positively to the Fed's actions, but some were quick to note that the Fed's loose policy may not be enough to drive additional buying.

Among the biggest gainers after the Fed statement were interest-rate sensitive sectors like utilities and telecommunications that react more to movements in rates than in anticipation of renewed growth. Energy shares were also stronger as crude oil rallied.

The market has already been concerned about valuations as earnings expectations decline, and the dollar's strength has driven those estimates lower in recent weeks.

© 2024 Thomson/Reuters. All rights reserved.

If the opposite of a tantrum is a happy dance, then that's just what stock and bond markets performed on Wednesday after the Federal Reserve sounded less likely to act aggressively in raising interest rates than investors anticipated.
federal reserve, interest rates, janet yellen, stock market
Wednesday, 18 March 2015 05:51 PM
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