Wednesday, December 16, 2015
Stocks are on track to build on the impressive gains from Tuesday by starting today’s session in strong fashion. All of this comes ahead of the key Fed decision coming out this afternoon that will represent a material change in monetary policy, and one that has long been expected by the market.
The only way the Fed’s decision on the lift-off question can surprise the markets is if it decides not to do it; markets are ready for a quarter-point rate hike and language that indicates a deliberately gradual trajectory in 2016. We endured a lot of market volatility on the lift-off question this year, but the sanguine tone at present reflects the view that the U.S. economy no longer needed the extraordinary interest rate regime that was put in place during the depth of the Great Recession.
Key areas of the economy like manufacturing and the broader mining and energy sectors are in bad shape, but the overall outlook for the economy is good enough for the Fed to start normalizing monetary policy. This morning’s strong housing starts data confirms the favorable momentum.
The Fed is very much aware of the fact that it is starting to raise rates at a time when all other major global central banks are in easing mode. The country’s two major trading partners in Europe and Japan are still fighting deflation with the help of expansionary policies, which have pushed those currencies to multi-year lows relative to the U.S. dollar. Most of those currency movements have likely already taken place in anticipation of what the Fed will announce this afternoon, but any change in the market’s expected trajectory of future rate policy will show up as an even stronger dollar.
The strong U.S. dollar has been weighing on corporate profitability in recent earnings seasons and has emerged as a major headwind for the export sector. Further dollar strength will not only exacerbate these issues, but will also likely further weaken the outlook for major emerging markets that are dependent on outside capital inflows.
We are unlikely to find anything dramatic at the end of today’s meeting, with the committee members’ interest rate forecasts most likely reiterating what they shared with us at the end of the September Fed meeting. The last ‘dot plot’ showed the committee members expecting 25 basis-point hikes at every other meeting in 2016, with the Fed Funds rate reaching 1.375% by the end of the year – the ‘terminal’ level was not expected to reach 3.5% till 2019.
Markets will likely cheer any perceived slowdown in this 2016 interest rate path.
Sheraz Mian
Director of Research
Note: In addition to this daily pre-open article about the market, economy, and the corporate earnings picture, Sheraz Mian also provides detailed earnings analysis in his weekly Earnings Trends and Earnings Preview reports. If you want an email notification each time Sheraz Mian publishes a new article, please click here.
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