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A month after raising rates, Fed faces darker global economy

The rate-setting committee of the U.S. Federal Reserve gathered in Washington for their regularly scheduled meeting on Tuesday, and will report a decision Wednesday afternoon.

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Shayne Heffernan Funds Manager at HEFFX holds a Ph.D.in Economics and brings with him over 25 years of trading experience in Asia and hands on experience in Venture Capital, he has been involved in several start ups that have seen market capitalization over $500m and 1 that reach a peak market cap of $15b.

Even before the massive 8% slide of the S&P 500 Index earlier this year, most investors were betting on only two Fed hikes in 2016, considering that cheap oil and weak inflation were the main challenges to policy tightening. And it just might work. Microeconomics explains the different effects of a price decline caused by increased supply versus one triggered by reduced demand. The key mechanism is that the announced plan should influence the expectations of firms and other agents as well as eliminate some of the uncertainty around future interest rates.

We expect the FOMC to acknowledge this volatility – it would be odd were it not to – but we believe that they will attempt to look through the near term wobbles. But the longer they persist, the more likely the Fed will have to adjust its expectations for raising rates. One factor is that widespread layoffs and spending cuts by oil drillers have offset some of the boost from steady consumer spending. Mr. Kaplan noted that the high ratios of debt to GDP in Japan, China, and the United States were possible hindrances to the growth of these economies. Any rough-and-ready schedule of interest-rate increases that the Fed might have had for 2016 – a dubious idea in the first place – can now be set aside. Dudley fears that if the unemployment rate falls much further, the Fed will be unable to achieve both maximum sustainable employment and price stability. Think about it like this. China’s leaders have struggled to steer the world’s second-biggest economy. “But the Fed’s appreciation of what is happening always seems to lag what is happening”, he concluded. But now it’s cutting back on stimulus rather than amping it up, leaving the economy more vulnerable. The only problem is there isn’t any evidence of that so far. It also seems that the consumer confidence and consumer sentiment may be outliers, with those remaining positive in January. Still, some economists suggest that if the Fed could have foreseen what has ensued in the month since it raised rates, it might have reconsidered.

It doesn’t have to, though.

The Federal Reserve may have set itself on the path to more interest rate hikes, but it’s likely to need to reverse course and cut by the end of the year, Mike Moran, head of economic research at Standard Chartered, told CNBC’s “Squawk Box”. This is an important point.

Markets never bought that forecast, and they buy it even less now. However, negative rates have not provided many economic benefits.

Option 2: Leave rates alone, but talk about raising rates soon.

Jordi Visser, chief investment officer of Weiss Multi-Strategy Advisors, a hedge fund, says: “I don’t expect any sign from the Fed this month, but I expect a gradual shift in the tone if financial conditions continue to weaken…” Did anyone ask the Fed if they would alter their policy decisions based on that? Not buying as many bonds as before is still buying more bonds, which according to every one of their models, should mean that money was getting more stimulative, not tighter. “The markets are going to drop until the Fed changes the game”. That could assure investors that the Fed will weigh such developments in deciding when to next raise rates.

If the recovery does come to a premature end, then, it won’t be because of low oil prices or China or whatever else you might hear.

World markets aren’t making things easy for the Federal Reserve.

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The flexibility to take advantage of such investment opportunities, when and where they arise, should help enhance investors’ fixed income portfolio performance.

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