Market commentary: US equity, credit markets rally after Fed raises interest rates

Yellen delivered as expected, and markets interpreted it very well as US equity and credit markets rallied strongly, with the momentum carrying through to Asia and the European markets this morning.

A very short-lived dip in the minute post lift-off aside, the S&P 500 rose strongly off its pre-hike levels to close up +1.45%, around a percent of which came post the news. The NIKKEI and HANG SENG closed up 1.59% and 0.79% respectively and in Europe the Euro Stoxx 50 is up 2.52%, with the Spanish and German indices leading, up 2.85% and 2.71% respectively.

In the credit space investment grade bond indices finished around 1bp tighter, while high yield continued its strong run this week to close nearly 11bps tighter and the two big US High Yield ETF’s were up close to 1% again. The VIX dropped 15% while 10y Treasuries finished pretty much where they were in the moments prior to the hike around 2.296% (up +3bps on the day), while 2y yields broke past 1% for the first time since 2010. The US Dollar was relatively unchanged versus the Euro while Gold was up over 1%.

Market direction has been rather correlated to the price of oil lately, however events from yesterday saw a divergence as the markets rallied despite a 4.9% fall in oil price, with the WTI falling back down below $36, which effectively reversed the gains made in the previous two days.

In yesterday’s statement, the FOMC committee described the outlook for economic activity as ‘balanced’ from the previous ‘nearly balanced’ statement, which is what spurred the markets on.

Investor focus was on the manner in which the Fed will determine the size and timing of future interest rate increases, with Yellen indicating that ‘the committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate’ before then emphasizing the dependence on incoming data. It was also noted that the Fed expects to maintain the current size of its balance sheet ‘until normalization of the level of the federal funds rate is well under way’.

2016 GDP growth was revised up one-tenth (to 2.4%), while the 2017 and 2018 forecasts were left unchanged at 2.2% and 2.0%. The unemployment rate is expected to decline to 4.7% for the next three years, which is down from the previous 4.8% forecast. Meanwhile the core PCE inflation rate was revised down one-tenth for this year and next (to 1.3% and 1.6% respectively) but left unchanged for 2017 and 2018, the latter being the year when the Fed expects to hit its 2% target.

In the post-meeting press conference Yellen said that the decision ‘reflects our confidence in the US economy’ and that ‘we see an economy that is on the path of sustainable improvement’. She highlighted that while developments abroad still pose a risk, these ‘appear to have lessened since last summer’.

This article was issued by Simon Psaila, Treasury Officer at Calamatta Cuschieri. For more information visit, www.cc.com.mt. The information, view and opinions provided in this article is 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.