Activity in the options market suggests stock traders are being cautious ahead of the Fed policy meeting on 15 and 16 December, and options expiry at the end of next week could amplify volatility.
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The fact that many small commodity producers, and oil companies in particular, borrowed money to finance expansion projects that made ideal sense with oil at $100 but now look like huge liabilities has had an effect on the high yield market.
When the FOMC does decide it’s time for lift-off, it’ll be up to one branch of the Federal Reserve System to execute the FOMC’s commands. The relevant data, however, indicates that the Fed’s widely anticipated move will likely have about as much market and economic impact as the much-feared Y2K computer panic that ushered in the millennium.
After seven years of near-zero interest rates, economists believe that the Federal Reserve will finally hike rates on Wednesday. It’ll signal that the USA economy is healthy enough to withstand higher borrowing costs for consumers and businesses alike. The Fed chose to delay a hike. The market is pricing in 2 to 3 more rounds of tightening next year so this possibility is not inconceivable.
“The Fed is going to package this announcement in a nice holiday box with a pretty ribbon on top”, said Sung Won Sohn, an economics professor at California State University, Channel Islands.
Officials have pledged to be data-dependent during this tightening cycle, raising rates in response to incoming economic and market information.
However, Alan Greenspan, the Fed’s chairman at the time, convinced policymakers to hold fire at that meeting arguing that he saw changes in the economy that were holding back prices and it later turned out that inflation indeed stayed low. “But don’t run out and buy a vehicle just because rates are rising”, he said. That statement heightened the stakes: While making a decision about initial liftoff, policy makers had been attuned to forward-looking inflation expectations rather than “actual progress”.
By year’s end, the European Central Bank, now led by Mario Draghi, changed course as the rate hikes and export-sapping appreciation of the euro pushed the economy back into recession. It may not take so long to know whether its decision was correct. When adjusting for inflation and employment growth, the Fed has kept to federal funds rate nearly 4% below where it should be (based on a forked-Taylor rule).
All investment eyes will be on how the NZ dollar reacts to the US Federal Reserve hiking rates this week.
With the subsequent calm in October and November, the Fed primed markets for an increase in December – only a week ago, a Wall Street Journal survey found that more than 90 percent of economists expected a hike.
“Some of the operational details will be under massive scrutiny”, TD’s Goldberg said. Hiking rates too early could make it more likely the U.S. economy tips into recession, he said. “Some rates have already started to move up in anticipation of the Fed”. Yellen has said she wants to see confirmation that inflation, which has been running below the central bank’s target of 2 percent for several years, is actually picking up. “They haven’t reached that point”.
Perhaps that’s the best Yellen and her colleagues could have hoped for in a post-crisis world.
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What investors should consider here is that the chances of a fed funds rate hike are well over 100% now for the January time frame. With most other aspects of macroeconomic policies essentially frozen due to political constraints – particularly fiscal and structural reforms – it will be up to the private financial markets to reconcile the policy divergence.
