The Federal Reserve Bank has boldly moved forward with plans to tighten US monetary policy as the world’s #1 economy gradually moves towards its targeted inflation rate of 2%. The Fed is tasked with two key objectives: full employment and price stability. To prevent the US economy from overheating, the Fed has embarked upon a policy of modest interest rate hikes. Currently, the federal funds rate (FFR) is in the range of 1.00% – 1.25%. The Fed FOMC convened on Tuesday/Wednesday (June 13/14) for its latest decision on interest rates. The Dow Jones wasted no time preparing for the Fed decision and rallied to a record high prior to the opening on Wednesday, 14 June.
US Markets Brace for Sustained Fed Action
Markets are more concerned about the Fed statement vis-à-vis inflationary expectations than they are about the 25-basis point rate hike announcement. The Federal Reserve Bank has been targeting a 2% inflation rate, but the PCE deflator (personal consumption expenditures) only measured in at 1.5%. With deflationary pressures weighing on the US economy, the Fed will want to act swiftly to prevent this. The Fed currently holds a bloated balance sheet valued at approximately $4.5 trillion. Janet Yellen, Fed president, has made it clear that the Fed will gradually begin unwinding its balance sheet by selling off its considerable asset holdings. As at 11 AM on the day of the Fed announcement, the Dow Jones was trading at 21,323.04, the S&P 500 index at 2,438.40, and the NASDAQ composite index was at 6,222.11. Over the course of 1 year these indices are up 20.64%, 17.50%, and 28.46% respectively.
Christine Lagarde Warns of Asset Bubbles Forming
Meanwhile, the head of the IMF (International Monetary Fund) Christine Lagarde is none too impressed with President Donald Trump’s decision to withdraw the US from the Paris Agreement. The Trump administration considers the climate accord to be detrimental to US interests, and the Trump administration wants to renegotiate the terms of the agreement to favour US businesses. Of particular concern to the IMF chief are emerging market economies throughout Africa. With widespread famine and starvation, surging levels of unemployment and high levels of migration, international consensus is needed with things like the Paris agreement. She’s also skeptical that US Federal Reserve Bank policy could result in asset bubbles forming.
Lionexo trading expert John Singeon Smyth believes that Fed rate hikes could have a positive effect on the stock markets. ‘We have already seen Wall Street reacting favourably to the prospect of rate tightening. Asset prices tend to perceive this as a vote of confidence in the performance of the US economy. Indeed, the Fed’s decision to raise the FFR indicates that economic objectives are being met.’ The decision to hike rates is justified, given the strong fundamentals of the US economy. However, we have been seeing too much ‘buying on the dip’ leading to rising asset prices which are not always justified by market conditions. This is true of the recent slide in tech stocks which were met with sharp increases in call options earlier this week. IMF chief, Christine Lagarde, is nonetheless convinced that the rate hike is warranted but a degree of caution is needed to prevent over-exuberance.
Disappointing Economic Indicators
Recent US economic indicators are a little disconcerting. Consumer prices only increased by 1.9 percentage points year-on-year in May, dropping from the April figure of 2.2%. Analysts were forecasting inflation of at least 2%. The reason for the sharp contraction was energy prices. Crude oil – Brent crude and WTI Crude oil – have been browbeaten of late with increases in inventory levels and production by key OPEC countries Libya, Iraq and now Nigeria. The current price of WTI crude oil is $44.85 and the price of Brent crude oil is $47.09.