Equity markets responded positively to today’s FOMC statement. The S&P500 added 1.2% to 2,090 while the Dow Jones gained 1.1% to 17,780. The US dollar rose and Treasury prices fell as the probability for a rate hike in December increased. The possibility remains for a rate hike before the end of the calendar year and it is also important to note that Yellen removed concerns of global risks to her guidance. Fed funds futures now reflect a 47% chance for tightening next month compared to 33% before the FOMC statement. The two year US yield rose 9 basis points to 0.71% while the ten year yield gained seven basis points to 2.10%. The dollar gained 1.2% against the euro to $1.0914 and rose 0.6% against the yen to Y121.14. Even though tightening expectations were pushed closer equity markets may have responded positively as a result of the Fed’s apparent faith in the US recovery. In contrast further easing expectations pushed the German bund yield down to 0.44%. The Swedish Riksbank held interest rates however expanded its quantitative easing package by Skr65bn to SKr200bn and extended the length of the program as well. The Australian dollar lost 1.3% against the US dollar to $0.7097 after inflation data missed expectations.
Markets respond to the Fed’s statement by increasing the likelihood of tightening this year. The Fed once again said that the economy was growing at a moderate pace that would warrant tightening if the expected trends continued over the following months. The omission of global growth concerns from the Fed’s statement may reflect that the central bank expects foreign monetary policy out of China and Europe to spur growth in the future and effectively stabilize the global economy. The outlook remains data dependent which makes the next two payrolls reports and upcoming inflation data even more important. The Fed maintains the stance that rates will not rise until the FOMC is “reasonable confident” that inflation will reach the 2% goal along with “some further improvement” in the labor market.
With rates set to rise in the US at some point over the next several months this puts increasing pressure on emerging markets. Expectations are at notable lows with commodity prices at all time lows and growth stalling. Investors have been willing to lend money to emerging market companies and governments as a result of the opportunity to realize higher yields than what were available in developed markets. Fixed income market flows into emerging markets totaled $1.2tn over the past five years compared to just $500bn for equities. In this way investors were betting on balance street strength as opposed to growth and earnings. According to a UBS strategist by gauging emerging market strength on the basis of leverage, external, fiscal, and governance risk, in addition to economic fundamentals these countries are still facing heavy downward pressure even in spite of heavy selloffs. Following years of heavy issuance the next few years will necessitate payments and maturities, and some issuers may not be able to weather the storm.