Fed announcement: And we have liftoff... - J.P. Morgan Asset Management
CLOSE

Fed announcement: And we have liftoff...

Contributors Global Markets Insights Strategy Team, Dr. David Kelly

As expected, the Federal Reserve (FED) raised short-term interest rates by 0.25% yesterday, ending seven years of a near-zero interest rate policy. This was a unanimous decision, and was based not only on the economic progress that has been made over the past few years, but also on the recognition that it takes time for changes in monetary policy to affect the underlying economy.

Backdrop

Since its meeting in March of this year, the Fed had indicated that it would begin to raise rates once it had seen further improvement in the labour market and it was confident that inflation would move back to its 2% target. Between February and November, the unemployment rate had fallen from 5.5% to 5.0%, and core CPI inflation had risen from 1.7% to 2.0% year on year. While many called for the Fed to raise rates in September, turbulence in global markets caused them to remain on hold. Looking at the fundamentals, however, the progress made since February more than justifies yesterday’s move.

What the Fed said and did

In addition to the increase in rates, the Fed updated its economic forecasts, reducing slightly the expected unemployment rate at the end of 2016 and 2017, but leaving estimates of economic growth and inflation largely unchanged for the next two years.

The Federal Open Market Committee (FOMC) marginally reduced the pace at which it expects to increase interest rates, now forecasting four rate hikes in 2016 and another four in 2017, compared with its previous forecast of four rate hikes in 2016 but five in 2017. The key thing to watch will be how market expectations adjust to the Fed’s new forecasts, as a Fed that hikes more quickly than the market expects could lead to upward pressure on the US dollar and a de facto tightening for the US economy.

Both in the statement and in Janet Yellen’s press conference, the Fed painted a relatively upbeat assessment of the current state of the US economy in justifying yesterday’s move. However, the Fed also stressed that further increases in short-term interest rates would be gradual and that it would continue to monitor both US economic numbers and global economic and financial conditions in deciding on future rate hikes. Importantly, Yellen emphasised in her press conference that “gradual” did not mean “mechanical”, suggesting that investors should not necessarily expect one rate hike at every second meeting, despite the overall expected trajectory of four rate hikes per year. The Fed also noted that it would seek to maintain its vast balance sheet of fixed income assets until “normalisation of the level of the federal funds rate is well underway.”

How markets reacted

Stocks rallied in reaction to the Fed’s statement, the 10-year Treasury yield remained relatively stable and futures markets continued to price in only two rate hikes in 2016 as opposed to the four that the FOMC members projected. The US dollar did not move significantly in response to the Fed’s action.

Investment Implications for 2016

The Fed will undoubtedly be pleased by the reaction to its relatively dovish language, as policymakers clearly wanted to avoid the complications that could have come from a spike in either the dollar or long-term interest rates. Nevertheless, aggregate demand in the US economy looks quite strong relative to anaemic supply, suggesting that unemployment will likely fall faster than the Fed anticipates. This, combined with some edging up in inflation pressures, could pressure the Fed to implement the four rate hikes in 2016 that it anticipates but the market doesn’t. This being the case, while the Fed’s action yesterday marks a vote of confidence in the US economy and is likely to be positive for stocks, it may entail more risks to the bond market than seem implied by initial market reactions.

Related products

JPM US Equity Income Fund
The fund focuses on high-quality US companies with healthy and sustainable dividends, providing lower volatility access to US stock market growth.
JPMorgan American Investment Trust plc
Managed by our locally based team of investment experts, this trust is a large, actively managed investment trust which aims to find high quality stocks in the core US market.
JPM US Select Fund
Our US Select Fund aims to identify attractively-valued long-term opportunities through a robust investment process powered by the insights of our US analysts.
Important information

Please be aware that this material is for information purposes only. Any forecasts, figures, opinions, statements of financial market trends or investment techniques and strategies expressed are, unless otherwise stated, J.P. Morgan Asset Management’s own at the date of this document. They are considered to be reliable at the time of writing, may not necessarily be all-inclusive and are not guaranteed as to accuracy. They may be subject to change without reference or notification to you. JPMorgan Asset Management Marketing Limited accepts no legal responsibility or liability for any matter or opinion expressed in this material.

The value of investments and the income from them can fall as well as rise and investors may not get back the full amount invested. Past performance is not a guide to the future.