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Market reaction to the Fed’s rate decision has been mixed, but who are the biggest winners and losers?

How are the markets faring after last Thursday’s Fed rate decision? Janet Yellen announced no change to short-term interest rates, but that doesn’t mean a rate hike isn’t just around the corner. Which asset classes will be impacted most by a rise when it comes?

Fed decides now is not the time to hike interest rates

Plenty of anxiety punctuated the markets in the days and weeks leading up to the Fed’s interest-rate decision on Thursday 17 September. The 12-member FOMC was tasked with a monumental decision, either maintaining near-zero interest rates in the US or hiking rates to embark upon a policy of quantitative tightening. Following the September 16-17 meeting, Fed chairperson Janet Yellen announced that interest rates would remain as is.

The FOMC and Board of Governors of the Federal Reserve were almost unanimous in their support of maintaining interest rates at their current level, 0%-0.25%. The lone dissenting voice in the 9-1 vote was that of the hawk Jeffrey Lacker. This is an important decision since it reflects how much the US economy is impacted by pervasive global economic weakness.

That the IMF (International Monetary Fund) cautioned the Fed and the Bank of England against hiking interest rates at this critical juncture is significant. It reflects the fragility of the global economic balance which is being tested by weakness across Asia. The Chinese equities meltdown spurred a worldwide rout that saw trillions of dollars erased from global bourses. As the world’s second largest economy slips further into a contractionary cycle, it is dragging commodities down with it.

These are some of the positive domestic factors that the Fed considered in its decision:

  • Unemployment rate of 5.1%
  • Business confidence of 51.1
  • Consumer confidence of 85.7
  • Retail sales growth year-on-year of 2.2%
  • A US inflation rate target of 2% with core inflation at 1.8%

However, it was the preponderance of weak global data that ultimately worked against the Fed:

  • Deflationary pressures in Japan
  • Negative impact of a strong US dollar
  • Persistent PMI and equities weakness in China
  • Widespread currency devaluations of emerging market countries
  • Capital flight from emerging market economies (BRICS and others)

What impact has the Fed decision had on currencies?

The most immediate impact of the Fed decision was seen in the value of the US dollar against a basket of currencies. The US Dollar Index plunged after the Fed decision and dollar weakness is likely to persist in the short term. The reason being, a rate hike would make the greenback inherently more attractive to foreigners. If the anticipated 0.25% increase in the interest rate had come to pass, the yield on dollar-denominated investments (Treasuries, fixed-income bearing accounts etc) would have risen. As non-US currencies are exchanged for the dollar, they weaken. Instead, we have seen the opposite taking place.

Virtually all emerging market currencies rallied in the run-up to, and the aftermath of, the decision even though that proved short-lived. On 3 September the US dollar index stood at 96.405 and by 18 September it had plunged to 94.221. This reflected speculative sentiment about the likelihood of a rate hike, and the sharp decline that followed the decision. It should be remembered that the threat to emerging market currencies remains. A September ‘hold’ does not rule out an October rate hike – Janet Yellen alluded to as much. While many currency traders enjoyed short-term bullish performance following the decision, EM currencies lost all gains soon thereafter.

How is gold faring?

The general rule is that gold soars when the dollar is weak. This is true since the precious metal is dollar-denominated. When USD is too strong, demand declines. Now that the short-term anxiety has dissipated, gold traders can breathe a collective sigh of relief. All precious metals rallied. In fact, soon after the Fed’s announcement the price of gold spiked to $1134.30. Silver gained ground too and was trading at $15.27. For now, it appears that gold is holding its gains in the market which makes sense since there is no interest to be earned in holding gold. That is precisely why gold flounders when interest rates are high.

How have global stock markets reacted?

Typically, when interest rates rise the effect is negative for stock markets. The basic reason for this is that the cost of borrowed money becomes more expensive. With higher borrowing rates for credit, profits invariably decline. This hurts the bottom line which translates into weaker EPS and dividends, et al. With no appreciable increase in interest rates, equities have no reason for volatility – in the short term. However, much of the anxiety in the markets has already been factored in (long before the Fed decision). Anxiety remains – in a deferred form – until the next Fed announcement.

European stocks slid following the Fed decision. And much the same was true for Wall Street. The reason for this seemingly contradictory outcome is that traders are flocking to the safe-haven asset of gold, en masse. With high levels of uncertainty abounding and USD weaker, gold has been tipped as the go-to asset class. The FTSE Eurofirst 300 plunged 1.8% by mid-day trading on Friday and the Nikkei 225 dropped off 2%. The S&P 500, Dow Jones and Nasdaq all traded lower. But the main reasons for the ‘stock-shock-drop’ are the following:

  1. Global uncertainty is high and anxiety remains until the next Fed meeting
  2. The Fed intimated that the dramatic slowdown of the Chinese economy halted a rate hike

Equities markets despise uncertainty while gold thrives under these conditions. We can expect much of the same moving forward.

Brett Chatz

Published: 21 September 2015

You should under no circumstances consider the information and comments provided as an offer or solicitation to invest. This is not investment advice. The information provided is believed to be accurate at the date the information is produced.

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