Decisions, decisions, decisions. This evening investors and market participants around the world will gain clarity on the most hotly anticipated monetary policy decision for many years when the Federal Reserve’s rate-setting committee will announce whether it will raise rates from the historic lows where they have sat since 2009.
For several years anxiety has ramped among investors that rising interest rates in the US and UK from their lows will be the catalyst to a bear market in global stocks and bonds.
Just a hint from the Fed or Bank of England that it might occur has been enough to knock back investor sentiment on several occasions in the past few years and this month’s meeting has been the most anticipated yet. On top of that, this year has not been a good one for most asset classes – in particular for fixed income funds with no sector strong in the face of rising rates.
Performance of sectors in 2015
Source: FE Analytics
At 19:00 [GMT] today the conclusion of the Federal Open Market Committee’s thoughts on where the Federal Funds Rate will be known and could offer the first interest rate hike since the 2008 global recession.
According to the US futures market, a proxy for traders’ and other investors’ expectations, there is about a 33 per cent chance of a rate rise.
However, even on a no change outcome, there is going to be greater market volatility, both on the statement and the subsequent new conference given by Yellen, says Simon Smith, chief economist at foreign exchange broker FxPro.
Eric Chaney, head of research at AXA Investment Managers is not expecting rates to rise today but says there is a good chance they will in which case the market reaction would be negative one for investors.
“If the Fed were to hike, the market reaction would be negative in our view, with risky assets and emerging markets (EM) suffering the most. If, as we believe, the Fed does not hike this week, there will still be a modest market reaction, gently positive for global equity, although emerging markets underperformance would likely persist,” he said.
He adds investors should think of the 2013 ‘taper tantrum’ as a blueprint for this scenario, with falls in the value of fixed income likely and a tough time for emerging market stocks.
“US bond yields would probably overshoot in the short-run, and we do not discount the possibility of 10 year yields touching 3 per cent.”
“Even though a September hike could be interpreted as the Fed being surprisingly confident in the US economy, we think global equity, and more generally risky assets - such as high yield - would suffer from this negative surprise in the short-run.”
Performance of index in 2013
Source: FE Analytics
Jim Leaviss, head of retail fixed interest at M&G says a rate hike today would surprise the market, but that it would not be the disaster that some are expecting
“Whether the Fed hikes or not is less important than determining where the terminal Fed Funds rate is in a potential rate hiking cycle. Fed tightening in this cycle will likely be unusually slow, cautious and well communicated to markets,” he said.
“In order to see bond yields move much higher, a reassessment of inflationary expectations would be required. A rising US dollar, benign wage growth, high consumer debt levels and falling commodity prices suggests to us that this is unlikely to occur in the short-term.”
Chaney says there would not necessarily be a blanket bearish outlook for all assets if the Fed does implement lift-off, and a buying opportunity in some.
“We think that this could provide a good opportunity to buy developed market equity, as a hike would not jeopardise the structural tailwinds supporting earnings growth, outside of the US where dollar appreciation would likely crimp dollar earnings more.”
He says emerging markets would in fact be the worst impacted region by a September Fed hike.
They are an area of the market which has been falling substantially over recent months thanks largely to recent events in China, but also as many are growing increasingly concerned about the impact tighter US monetary policy would have on those economies – especially those with large amounts of dollar denominated debt.
Performance of indices over six months
Source: FE Analytics
“As a side effect of the US accommodative monetary policy, emerging markets saw large capital inflows starting early 2009 for equity and mid-2009 for debt portfolio flows, partly reversing during the taper tantrum - mainly as far as debt is concerned - then again recently this time mainly with equity portfolio outflows as a financial spill over effect of market fears over China.”
“On a cumulative basis, ‘hot money’ in emerging markets remains very large and, based on an event study of the taper tantrum, we estimate that net capital outflows, especially bond net flows to EMs, would quickly and sharply deteriorate.”