Stocks fall following the FOMC statement in spite of stability in oil prices. The S&P500 fell 1.1% to 1,882 and the Dow Jones fell 1.4% to 15,944. Investors and traders appeared to be hoping for a more dovish statement from Janet Yellen since stocks had risen earlier in the session before easing back after her comments. While the Fed did acknowledge that it would closely monitor global developments the statement failed to indicate that the global environment would weigh on US growth and inflation and alter the Fed’s trajectory of interest rates. As a result some analysts believe that a rate hike in March may be still on the table. Brent oil rose 4.1% to $33.10 and WTI gained 1.6% to $31.96 on rumors of potential supply cuts from Opec producers. Indices in China fell after data showed that industrial profits in December fell for the seventh consecutive month. The US 10 year was flat at 2.00% and the 2 year fell 1 basis point to 0.84% as it seems investors are calling the Fed’s bluff on higher rates potentially as soon as March. Similarly the euro gained 0.2% against the dollar to $1.0892. In New Zealand the kiwi fell 0.9% against the dollar to US$0.6642 after the central bank opened the door for future easing.
The Fed is paying attention to the volatility and uncertainty that are plaguing global markets however it failed to deliver any hope that conditions would alter the Fed’s course. Interest rates were left unchanged at 25-50 basis points as was expected by everyone, however the Fed left its options open regarding potential hikes in the future. If the Fed sticks by the dot plot made in December then there will likely be four rate hikes this year. Markets do not believe that this is a likely option given the state of uncertainty in the global economy however today’s comments suggest that the Fed may stick to its original plans barring unforeseen developments.
In spite of a dovish tone in the FOMC statement Treasury yields fell after the announcement. Normally when the Fed indicates that rising interest rates are a possibility then yields would rise, especially when market previously had been expecting them to come across dovish. This may reflect traders and investors expectation that market conditions will prevent the Fed from raising interest rate in March, essentially calling the Fed’s bluff. Although the Fed did express caution and concern over the landscape, no indication was made that the committee was deterred from its original plan to raise rates four times this year. The statement therefore had opposite effects on both the stock and bond market. Stocks sold off because the Fed was not dovish enough, and yields fell because the statement was apparently not enough to convince investors that the Fed would take action in March. Before the FOMC statement Fed funds futures reflected a 34% chance that the Fed would raise rates, and after the statement the market reflected a 29% chance. Only one rate hike is priced into futures markets for this year.
Troubled stock markets in Asia have spilled over into the bond market. In some situations investors have been forced to liquidate bond holdings in order to compensate for heavy losses experienced in the bear market in equities, which reflects portfolio contagion. So far throughout the equity selloff bonds have held up relatively well however last week total returns for bond funds turned slightly negative to -0.4%. As would be expected, the selloff has mainly affected the high yield aspect of the market as investors adjust for their risk tolerance within credit. Contributing to the selloff is the fact that in the past few years the amount of outstanding debt in Asia, particularly high yield, has increased dramatically. Between 2011 and 2015 $94.4bn was raised in high yield Asian bonds compared to just $41.7bn between 2006 and 2010. Although the discrepancy may be skewed by the financial crisis and fallout experienced in 2008, nevertheless it shows that there has been a substantial rise in debt levels among the riskiest companies in the region. Now as economic conditions around the world and especially in Asia begin to deteriorate, the time of reckoning appears to be coming closer for the market.