Many people have predicted a collapse in markets as rates move up and this has periodically caused concern in equity markets. As expected, the Federal Reserve (Fed) did not raise rates this week but still indicated that a rate rise was possible before year end, most likely at the December meeting due to the election. This is subject to the economy continuing to improve as they anticipate. Subsequently, US equities moved about 1% higher. However the Fed has revised their expectations for the future path of rates and the long run funds rate lower.
At the end of last year the median expectation from the Fed was for four quarter point rate rises in 2016, four more in 2017 and a long run rate of 3.5%. So far this year rates have not moved and yesterday’s meeting predicted a quarter point move in December, but only two further moves in 2017 and a long run rate of 2.875%.
Elsewhere in the world rates are, if anything, moving lower. We saw a further tweak to Japanese monetary policy this week and expect more action from the European Central Bank. In the UK, the Bank of England has indicated that it is ready to cut rates further depending on the impact of the Brexit negotiations that have yet to get going in any meaningful way. With US rates potentially moving up the Fedwill be monitoring the impact of any subsequent strength in the dollar on US company earnings and inflation.
As the oil price falls come out of the annual inflation figures these are likely to rise, giving the Fed room to raise rates. Last year we saw the first rate rise in the cycle and equities survived this. I believe that the Fed will not want to damage equity markets or see too strong a dollar and therefore expect rate rises to be very gradual. The so called “dot plots”, that indicate Federal Reserve individual committee members views in their report, appear to support this view.