Drawing the curtain on a seven-year period of low interest rates, the Fed said on Wednesday that it is beginning a cycle of monetary tightening. This was probably the most widely awaited financial and economic announcement of the year and will have ramifications across the world. Expressing confidence in the U.S. economy, Fed Chair Janet Yellen announced the beginning of a slow-but-steady series of rate increases.
While markets greeted the news with cheer, worries can be felt below the surface. These range from whether a hike was necessary at this time to fears that the Fed should have increased rates much earlier.
Inflation Worries Persist
While the Fed Chair has expressed confidence in the strength of the labor market resurgence, fears about inflation remaining under par persist. Inflation has remained below the central bank’s 2% target for a period of three and a half years. Despite positive CPI data, increases have been halted by the oil price plunge. On Wednesday, oil prices plummeted to their lowest level in nearly seven years.
These concerns were reflected in the Fed’s policy statement. Yellen has also assured that the central bank could change the path of planned gradual increases in case inflation remains below par in the future.
The Fed would not like to see inflation remaining under its targeted level for an extended phase. This would indicate that the economy’s performance is still far off its potential. Ultimately, the fate of price increases will be determined by the strength of the domestic economy, a fact also made clear in the Fed’s policy statement.
Weak Data Could Hinder Growth
Despite a spurt in GDP, pockets of weakness can’t be ignored. According to a government report released on Thursday, industrial production suffered its worst fall in excess of three and a half years in November. This was primarily on account of the poor performance by utilities.
Such poor numbers could mean that growth in the fourth quarter could be thwarted. Industrial production fell 0.6%, following a 0.4% decline in October. This marks a third consecutive month of downward movement.
Earlier in the month, the ISM manufacturing index declined from October’s 50.1% to 48.6% in November, in contrast to the consensus estimate of a rise to 50.4%. The ISM manufacturing index dropped to its lowest level in November since mid-2009.
Separately, Markit’s final PMI manufacturing index came in at 52.8% in November – a 25-month low. Additionally, The Institute for Supply Management reported that ISM Services Index decreased to 55.9% in November from October’s reading of 59.1%. The drop was deeper than the consensus estimate of a decrease to 57.7%.
Dollar Effect
Following the Fed’s announcement, the dollar surged to a two week high versus a basket of several important currencies. A 0.25% increase in the benchmark rate was enough to trigger a 1% gain for the dollar versus a basket of currencies. While this is expected to have an adverse impact on emerging markets, even the domestic economy may not be spared.
This is because it will raise the price of exports. Domestic manufacturers are already finding it difficult to cope with a surging dollar. Oil has been affected the most even when it is suffering from a combination of weak demand and oversupply. Dollar-priced oil will now become costlier for those making purchases using other currencies. Market watchers believe that this will be detrimental to crude prices.
Weak Global Demand
On the demand side, global requirement has been falling for some time now. The ECB has failed to provide monetary stimulus that matches up to market expectations. Meanwhile, fears pertaining to China’s economy persist as the country undergoes the pains of transforming into one which is consumer driven and dependent on new economy companies.
Emerging economies may also find the going tough. Apart from the U.S., a few economies promise growth. This will continue to hamper the export-oriented sectors of the domestic economy as well as multinational corporations.
5 Biggest Losers
These are the five biggest losers of Thursday following the Fed’s rate hike decision. We have omitted those stocks that have moved southward on company-specific developments.
Mistras Group, Inc. MG declined 13.9% to $18.42
Voyager Therapeutics, Inc. VYGR declined 6.5% to $19.64
Energen Corp. EGN declined 6.3% to $46.70
SM Energy Company SM declined 6% to $21.62
Concho Resources, Inc. CXO declined 5.9% to $102.15
Bottom Line
Ultimately, the efficacy of the Fed’s plan to increase rates gradually will depend upon the strength of the real economy. Several indicators show that such concerns are not unjustified. In fact, the Fed too has acknowledged them with its decision to moderate the tightening cycle in response to such conditions.
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