Tags: market | fed | reaction | rate hike

6 Facts About Market's Reaction to Fed

6 Facts About Market's Reaction to Fed
(AP/Susan Walsh)

By    |   Friday, 17 March 2017 06:56 AM EDT

The markets’ immediate response to the Fed's hike on Wednesday included an impressive run-up in stocks and significantly lower yields on U.S. government bonds. Some market observers hailed the benefits of a “dovish hike” by a “Goldilocks Fed.”

Others cautioned against overextrapolating from what was mainly a technically-driven move. In assessing these and other views, here are six things you should know about the drivers of this unusual market reaction and some implications for what may lie ahead.

  • Before the Fed announcement, some traders were positioned for a more aggressive upward revision in the “dot plot” that shows Open Market Committee members’ expectations for the path of future interest rates. In the event, the Fed kept the 2017-18 rates guidance unchanged. Moreover, even though the Fed had succeeded in the run up to the meeting to significantly raise market expectations of a March rate hike and then validated it by a policy action, Chair Janet Yellen stated more than once in her press conference on Wednesday that the central bank’s economic assessment had not changed since its last policy meeting in January.
  • This dovish spin to the rate hike sent shorts scrambling to cover their offside bond positions. The resulting generalized downdraft in yields on U.S. Treasuries gave stocks a further push up, while strengthening hope that the Fed could deliver a “beautiful normalization” of rates (the materialization of which depends, importantly, on domestic and international factors that are beyond the Fed’s sole control).
  • Going forward, all this will boost the Fed’s policy confidence as it gradually transitions its policy regime beyond data dependency, and as it feels more comfortable about leading markets rather than following them. As such, and in a notable departure from the last few years, it is more likely that market expectations for the medium-term path of rates will slowly migrate up to the Fed’s, rather than convergence happening the other way around.
  • This gradual convergence will be reinforced by what is likely to be a policy shift in the Fed’s balance of risk assessment in the next few months. Based on the likely evolution of domestic and international conditions, the Fed will probably signal that, if a total of six hikes for 2017-18 does not remain as the baseline, it is because a rate increase is more likely to be added than taken away. This hawkish evolution in the balance of risk would be followed by a more definitive Fed signal should the administration and Congress deliver on the pro-growth policy trifecta (deregulation, infrastructure and tax reform).
  • The prospects for such policies will influence more than the Fed. In their ongoing shift from a “Fed put” to a “presidential put,” stocks have already been pricing in a Trumponomic-driven boost to economic growth, company earnings and the repatriation of corporate cash back to the US. Favorable policy expectations have also fueled a tide that has lifted other risk assets, including corporate high yield bonds, despite some having excessive leverage, record debt issuance and shaky credit quality.
  • All this leaves investors with a more complicated portfolio proposition now that stock indexes have rallied significantly and the lagging sectors (such as tech and emerging markets) have been playing catch up. Increasing risk exposure now becomes even more of a bet on domestic politics and enabling international conditions.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Mohamed A. El-Erian is a Bloomberg View columnist. He is the chief economic adviser at Allianz SE and chairman of the President’s Global Development Council, and he was chief executive and co-chief investment officer of Pimco. His books include “The Only Game in Town: Central Banks, Instability and Avoiding the Next Collapse.”

© Copyright 2024 Bloomberg L.P. All Rights Reserved.


MohamedElErian
The markets' immediate response to the Fed's hike on Wednesday included an impressive run-up in stocks and significantly lower yields on U.S. government bonds.
market, fed, reaction, rate hike
619
2017-56-17
Friday, 17 March 2017 06:56 AM
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