Later today we get the long awaited Federal Reserve decision. Why the possibility that US interest rates could go from 0.5% to 0.75% is making quite so many headlines is hard to fathom in some ways. Markets in Europe had a strong day on Monday as did stocks in the US, at least initially. It felt that traders could have been short covering ahead of the Bank of Japan and the Federal Reserve announcements.
Early on Wednesday morning the Bank of Japan announced that it had left interest rates at -0.1%. The Bank of Japan did not increase its purchase of Japanese Government bonds. The Japanese yen hardly reacted relative to the US dollar post this announcement. The Bank of Japan did introduce measures to steepen the yield curve, in an attempt to help bank profitability but overall the view was that there was nothing too radical in the release.
Should the Federal Reserve raise rates later today, unlike July, one gets the sense this would catch equity and bond markets on the hop. According to a CNBC poll, 90% of those polled do not believe the Fed will move. How the capital markets will react to an unexpected move by the Federal Reserve probably depends on what they decided the rationale behind the decision was. Would the view be taken that the Federal Reserve raised interest rates just to protect their credibility? The start of the year the Federal Reserve anticipated 4 rate hikes in the year.
Post the interest rate decision the Federal Reserve will announce a summary of its economic projections. If they do not raise rates one can only assume these projections will be down beat and Janet Yellen’s press conference will likewise be dovish. Rational thinking would suggest a lack of economic optimism from the Federal Reserve would be taken poorly by equity investors. How much this lack of economic optimism, which continues to be offset by the low interest rate policy, can boost equity markets is an unknown. One has to assume there has to come a point when the current status quo ends. On the other hand, should the Federal Reserve move Janet Yellen would be expected to paint an optimistic outlook for the US economy. This in theory should be a positive move, for equities at least. The question would then be how would the bond market react? The recent spate of economic data, has been weaker than expected, Janet Yellen may well be asked to address this point and explain why she felt this trend was likely to change in the coming months to justify the rate rise. The worst case outcome for capital markets would probably be if the Federal Reserve raise rates as they start to see greater inflationary pressures but continue to paint a picture of modest economic growth.