Market commentary: To hike or not to hike?

After reversing early losses, European markets closed in positive territory yesterday and extended gains this morning, with most of the equity indices advancing close to 1% within the first hour of trading.

Investors are buying into stocks ahead of a key and closely watched two days Federal Reserve Policy Meeting starting today, as markets believe that the US Central Bank may be finally ready to raise interest rates. US equity futures are also in the green, suggesting a strong US opening, as traders and investors prepare to adjust their strategies in order to capitalize on a possible end of the week rally.

Meanwhile, analysts continue to debate on the outcome of this highly anticipated FOMC meeting, with a number of market participants believing that the markets and the US economy may be finally ready to withstand an interest rate hike and the end of a prolonged period of zero interest rates.

In fact, while many agree that an interest rate hike from the Federal Reserve is likely to further contribute to the already unusually high volatility in the markets, they also recognize that, by rising interest rates, the FED will confirm the solid health of the US economy and the end of the need for “free money” to avoid any imminent economic downturn.

Over the last couple of months, US monetary policy makers have increasingly argued for the need to end the current monetary easing environment by starting to normalize interest rates, the US credit market and ultimately the global economy, which has been operating on the back of Central Bank support for the last seven years.

Supporting this view is a string of positive economic data, such as the US unemployment, which has declined over the last few months, the US housing market, which has been gaining additional traction over the summer, and US consumer spending numbers, indicating that the economic benefit of low oil prices have finally started to make their way into the real economy.

However, not everything is as good as it seems, and a still sizable number of economists is arguing in favor of postponing any interest rate hike at least until the end of the year, in order to give the Federal Reserve time to assess the negative impacts of China and the strong dollar.

In fact, although a rate increase is becoming widely expected, China and its role in causing last month’s global selloff is indeed weighting in favor of postponing any major monetary policy change.

While the economic slowdown of the second world largest economy is hardly a new news, the Chinese stock market collapse and the sudden liberation of the Yuan have brought havoc in the financial markets and have raised serious concerns over the prospects for future global growth.

If China is perhaps representing the major obstacle in the FED’s path to a rise form a global economic prospective, the strong dollar could also be another consideration.

In this regard, many analysts think that the current level of the US currency will start, sooner rather than later, to erode corporate earnings and private sector’s margins, while also continuing to be a drag for the country’s inflation, which is still trending far below the FED’s 2% target.

Therefore the real question the FOMC is expected to answer is whether the US economy is strong enough to overcome both a strong dollar and a potential global economy slowdown.

With these issues on the table and the possibility to spook emerging markets, whose economies are already under pressure and whose currencies would most likely further devaluate should a US interest rate hike materialized, policy makers are expected to undertake a rather animated discussion over the next two days, giving investors reasons to bet that equities will continue to gain throughout the rest of the week.

Disclaimer:

This article was issued by Paolo Zonno, Trader/Analyst at Calamatta Cuschieri. For more information visit, www.cc.com.mt .The information, views and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice. Calamatta Cuschieri & Co. Ltd has not verified and consequently neither warrants the accuracy nor the veracity of any information, views or opinions appearing on this website.