The latest US Federal Reserve meeting, the first to be chaired by Janet Yellen, delivered a slightly more hawkish outcome than expected.
While the commentary was broadly unchanged, the survey of the rate-setting committee members brought forward the date of the first rate rise and increased the median expected interest rate to 1 per cent by the end of 2016.
This alone may not have unsettled markets, but the off-the-cuff comments by Janet Yellen in the subsequent press conference, implying that she defined a “considerable time” between the end of quantitative easing (QE) and the first rate rise as being “something in the order of six months”, certainly caused some upset.
This was interpreted as suggesting the first rate hike could be in spring 2015, much sooner than many were expecting given the use of the phrase “considerable” in the Fed’s statement.
The backdrop for US interest rates is shifting from ‘lower for longer’ to a slow normalisation, albeit to a level lower than in previous market cycles – roughly 4 per cent.
The change to forward guidance – removing the 6.5 per cent unemployment threshold as a trigger for rate rises to be considered and using a broader range of labour market metrics – allows the Fed to maintain credibility and not be forced into action ahead of their wishes.
Given that inflation remains well below target, they have plenty of scope to stay on hold for some time.
However, an interest rate policy put in place at the time of the biggest financial crisis for more than 50 years cannot be appropriate in a year when the US economy is set to grow by close to 3 per cent, according to the Fed’s own forecasts.
Markets have been cosseted by QE and near-zero interest rates for five years. The process of normalisation will cause some volatility and pain, but should be seen in a positive light, given this means the US economy is moving onto a sustainable growth path.
Globally, we may well see a renewed focus on the more vulnerable emerging markets and their currencies as the investment world rebalances for rising US rates.
Following on from the unease in January, we have seen calm restored and emerging market currencies have stabilised.
However, renewed tensions – the catalyst for which may be elections over the coming months – could well put the spotlight back on those countries with the worst fundamentals or the least credible central banks.
The withdrawal of QE may well be offset in the US by the improving economic backdrop, which should be supportive of earnings and equity prices. The market may be more selective however: companies whose fundamentals and earnings are less attractive could well underperform.
We believe the US economic outlook is improving, but the market outlook is a little less clear. It would be a different story if the US stockmarket was not already at record highs, but a rebound in the data – following on from a severe winter which has had a short-term impact – and a supportive earnings season could see equities break out of their current holding pattern on the upside.
