Davy Asset Management Market Comment: Federal Reserve Announcement

With economic conditions improving strongly in the US there was a growing number of market participants who thought the Fed would undertake their first rate hike in almost 10 years at their September meeting. However despite full levels of employment having now been reached the Fed decided not to move.

In her press conference Janet Yellen cited recent instability in financial markets
and economic weakness in China and other emerging markets as the main reason the committee decided not to move. Although in the accompanying statement the Fed noted that “economic activity is expanding at a moderate pace” and that “the labour market continued to improve” the tone of the statement was dovish overall. The impact of the stronger dollar was also taken into account noting that net exports have been “soft” and a stronger greenback could continue to put downward pressure on inflation.

The reasons for the decision drew criticism from some parts of the market that the Fed has now become the ‘world’s’ central bank. In fact many lay the blame for much of the instability on the Fed and that delaying rate hikes will only lead to further uncertainty in the weeks and months ahead until they finally raise rates.

Despite the more dovish tone the door was left open for a move this year, including October, but once again the timing was downplayed with the expected path of rate rises seen as the more important factor. In fact 13 of the 17 members still expect rates to move this year but this is down from 15 at the last meeting. One member dissented but is set to leave the committee in the coming months.

In terms of the market’s response to the announcement we saw the US 10yr yield have its largest downward move since January, falling over 10bp to close at 2.19%, having drifted to 2.30% in anticipation of the announcement. The dollar was weaker overall with the down -0.91% on the day, and EURUSD closing over $1.14 last night. US equity markets having initially taken the news positively were up almost 1.3% before closing in negative territory. In Asia we have seen a mixed response with major Chinese markets finishing in positive territory, while in Japan both the Topix and Nikkei were down c.2%. European markets have also opened on a weaker footing in response to the announcement.

The futures market is now pricing in only an 18% probability of a hike in October, and a 46% probability of a move in December. We expect that the Fed’s indecision could lead to further volatility in financial markets, however we may see an initial pickup and stronger markets in to year end.

Warning: This information does not constitute investment advice or a recommendation. It has been provided for discussion purposes only. The information contained herein does not purport to be comprehensive. It is strictly for information and discussion purposes only. No investment decision should be made on the basis of this report.

Davy Asset Management is regulated by the Central Bank of Ireland.