Interactive Investor

Fed doves keep investors guessing

18th September 2015 11:17

Lee Wild from interactive investor

So, the Federal Reserve lost its bottle and decided to keep US interest rates unchanged. It was hardly a surprise, and, as is often the case with heavily-hyped decision days, the immediate response by markets has been something of a disappointment.  

We argued in favour of a "suck it and see" rate rise in September to avoid weeks or months of uncertainty and ergo stockmarket volatility. True, the outlook for inflation is more benign, the dollar too hot, and China is having a wobble, but strong US economic growth and low unemployment could easily absorb a small rise in borrowing costs with further tightening delayed until next year.

Still, hold it has, and attention now switches to the Fed's next meeting next month. What policymakers will discover between now and then is unclear. One suspects not much. That's why December is now the bookies favourite for a first rate rise in over nine years.

"We think that three more months of labor market improvement would stiffen the Committee's spine against waiting for perfect conditions for lift-off," says JP Morgan's chief US economist Michael Feroli. "We now look for a first hike at the December meeting, and still project one hike by year-end and cumulatively five hikes by the end of next year."

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With core inflation also expected to accelerate more slowly, UBS has also cooled expectations for the monetary tightening cycle. "We now expect a 25 basis point (bp) rate hike at every other meeting in 2016, for total tightening of 100bp. The year-end 2016 Fed funds target range forecast is now 1.25-1.50%."

The initial reaction on Wall Street, however, epitomised the nervous mood caused by last month's major sell-off. Stocks sold off on the initial announcement and the S&P 500 dived into negative territory. It then rallied 1.4% before Fed chairwoman Janet Yellen's comments at the post-decision press conference caused a pullback into the red to session lows. Banks, which typically do well when rates are rising, fell sharply.

"Markets now have got what they asked for, we therefore expect little reaction with a slight positive bias for risk assets," says Asoka Wöhrmann, chief investment officer at Deutsche Asset & Wealth Management.

Footsie remains highly volatile

Over here, the FTSE 100 (UKX) declined as much as 50 points in quick time, but is currently down 28 at 6,159. It remains highly volatile. Engineers – Rolls-Royce, BAE Systems and Smiths Group are struggling, offset only partially by gains at gold miners Randgold and Fresnillo, and among the major real estate plays – British Land, Land Securities and Hammerson - and housebuilders – Taylor Wimpey and Persimmon. Judging by the chart above, however, the blue chip index must break resistance at the downtrend line to end this rangebound trade and establish a platform for any subsequent rally.

Predicting where any of the major indices are heading is a fool's game currently, although it's fun trying. Share prices will remain jumpy, that's for sure, but there are opportunities for investors with a longer time horizon.

Nigel Green, founder and chief executive of financial advisor deVere Group, certainly thinks so. "It is critical to remain aware of the volatility and its causes, to have a fully diversified portfolio across asset classes, geographical regions and industrial sectors to manage risk, and perhaps to begin to consider the effect of a possible market correction on portfolios.

"However, there is a significant amount of potential upside too. Equity valuations do appear to be fundamentally sound, so any China or US rate-related volatility is perhaps worth taking advantage of where possible."

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.