US Fed Rates

Will they call a halt to rate hikes in March?

The US FOMC meet that concluded on January 27th was significant in more ways than one. The FOMC meet clearly acknowledged that the global situation was indicative of an overall slowdown and hence may not be conducive to rate hikes. The FOMC also conceded that the US economy may not be growing as robustly as it seemed to grow in 2015 and that may be another tacit admission by the committee. But most importantly, the minutes also focused on the need to adopt a wait-and-watch approach to rates in the current circumstances. Why is this critical?

Reacting to the January fall…

 The impact of the Fed rate hike on December 15th was not immediately visible in the month of December. But in January as cheap oil combined with a weak China, the impact was visible. The world stock markets lost close to $8 trillion in market cap as markets across Asia, Europe and the US were battered. The NASDAQ has lost nearly 20% from its peak and is nearly 600 points below the psychological mark of 5000. The month of January was also a reaction to the tight liquidity conditions created by the 25 basis points rate hike in December. If the US Fed went ahead and hiked rates by a full 100 bps in 2016, it is anybody’s guess what could be the outcome. That thinking may largely determine the strategy the Fed will adopt as it prepares for its next meeting in March this year.

Will it be a pause in March?

As per the December FOMC minutes, the US was supposed to hike rates by 100 points by the end of 2016. That would have logically implied the first hike of 25 bps in March. That is exactly what the markets were worried about. Post the January reaction, the US Fed may want to rethink its original idea of hiking the rates in March. Remember, 2016 is an election year and the US will not want to tighten conditions at a time when growth, wages and spending are not really picking up. Also China is a major cause of concern due to its strong externalities with half of the world’s economies. The Fed statement that it will be driven by data is the first admission that rate hikes will be postponed to the second half of 2016 till there is clarity on oil prices and China.

What does this mean for markets?

This will surely be a leg-up for markets. The risk-off trade created by the rate hike may reverse in favor of emerging markets and that will be good news. Also the liquidity concerns will vanish, at least for the time being. But, above all, the big advantage of a postponement of rate hikes will be that monetary divergence will not be a major risk for global markets. That fear has already caused substantial volatility, as indicated by the VIX. That is a surely a good reason for global markets to start the process of bottoming out! ©

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