Who's Afraid of the Big Bad Fed?

Michael Van Dulken |

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Markets are obsessed with determining when the US Federal Reserve will raise interest rates for the first time since 2006, from an all-time low since 2009, just as they got caught up with ‘when’ it was going to start tapering its third round of QE (QE3) in 2013. Once again, we know that it will happen as US monetary policy continues to normalize, but again, we’re making a big deal of it. Surely the fact we know it is on the cards is more important? Whether it is delivered in Q3, Q4 or Q1 is far less significant. There is no surprise. Why aren’t investors/traders and markets pricing it in already? Where’s has market efficiency gone?

The problem stems from this era of artificially cheap money and monetary stimulus helping equities to all-time highs. Nobody wants the music to stop, or the party to end. Markets have become extremely short-term, partly on account of the bull/bear swings during the financial and sovereign debt crises, and now invest/trade around Fed communications and the hope of low interest rates sticking around for just that little bit longer. Why? It’s going to happen - move on. Because it’s the USD. It’s the commodity currency. It’s the other half of most FX trades. Its strength can be the help (for other currencies) and hindrance (hurts commodity prices). The knock on is far more than just stateside.

However, the Fed was the first to act in terms of extreme policy (low rates, QE) and duly followed by the Bank of England, Bank of Japan and after a rather long, drawn-out (but cleverly orchestrated) wait, the European Central Bank. So it’s only natural that it is first to begin normalizing. And while it may have done more than most central banks in terms of stimulus on account of the USD being the global reserve currency the fact that its major peers are still at it (all low rates, BoJ and ECB still engaging in QE) means that global cheap money isn’t suddenly going to disappear when the Fed moves. Far from it. The ECB is set to buy €60bn of bonds until Sept 2016, unless inflation suddenly surges. And even then we’ll probably have a wait until the first ECB rate rise. The BoE may have stopped QE, but will likely only raise rates after the Fed. The BoJ still has plenty of work left to do.

What's so Scary About Rising Interest Rates?

On top of that, after such a period of low rates, nobody is going to suddenly hike them back to their prior norms. So what are we scared about? The Fed and BoE have been clear that when rates do take off from their lows that the pace of increase will be gradual. Very gradual. It has to be. Think about it: This is a new era, after a never-before-seen financial and sovereign debt crisis. It’ll be a case of gently testing the water, avoiding big ripples. All that cheap money lent to stimulate the economy can’t be reversed quickly. While each central bank’s new boss (Yellen, Carney, Draghi) will want to make their mark, none of the trio will want to be remembered for undoing the work of their predecessor and sending respective economies back into trouble.

While ECB President Draghi might be last to move, he definitely won’t want to mess up the Eurozone either, potentially having more to lose should another crisis erupt. They say the trend is your friend, and an increase in US rates from near ‘zero’ will constitute a doubling but it doesn’t mean rate hikes will be a given every time the Fed meets. Or that peers are set to follow suit immediately after. Look at how murky US data has been of late, scaring the Fed away from an already significantly delayed first hike. Why not expect that trend to continue a while longer and keep the music playing?

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

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