At last, we can all breathe again ..... until the next time.

Thursday 17th December 2015

At last, we can all breathe again ..... until the next time.

Ref : All outlets, everywhere

There can only be one story today, and of course it's the US Federal Reserve finally raising the Fed Funds rate by 25 basis points from a zero to 0.25% band to 0.25 to 0.50%. Even up to the moment of the announcement, futures markets still suggested that the probability of a hike was (just) 74%, and there were quite a few well-respected commentators urging the Fed to stay its hand (including the editorial in the FT, incidentally). Of course, WANTING them to follow your advice and EXPECTING them to do so are not the same thing but in hindsight there's a case for saying that we probably shouldn't have been as certain that the Fed were going to hike as we were. So, there was an element of relief in seeing them grasp the nettle at last.

Actually, since the rise was announced RELIEF seems to have been the operative word. There's been no evidence of any panic, particularly in emerging markets, that some suggested would be the result of a Fed move. For some time we've subscribed to the alternative view that the uncertainty created by the possibility of an impending rate rise was in fact more damaging than a 25bp rise itself would be, and it seems to have panned out that way. The dollar has gained about a cent over the Euro which may indicate that perhaps it was not quite priced in fully by foreign exchange markets, but stock and bond markets have also risen .... which one would not theoretically expect after a rate hike in more normal conditions. The fact that everything has gone so smoothly has led to Fed Chairwoman Janet Yellen receiving a few pats on the back for the excellent "forward guidance" she has shown to the markets ..... it might be considered uncharitable to bring to mind that in our view the Fed's communication processes have less than uniformly praiseworthy, so we'll let her take the plaudits ahead of even tougher tests to come.

If you believed that yesterday's rate hike was pretty much a racing certainty, then your focus was always going to be on what Ms Yellen said with regard to the future, and in particular what she had to say about the pace and steepness of further rises. You'd have to say that her communication on that front was pretty clear .... apparently, she used the word "gradual" no less than 13 times and reiterated the fact that the Fed's actions would be data-dependent. One could argue that of course any central bank's actions are bound to be data-dependent and it's a phrase that gives them the leeway (rightly so) to react to unforeseen circumstances, but still .....

Whether you want to call it gradual or not, the release of the (in)famous "dot-plot" yesterday revealed that on balance the members of the Fed's Open Market Committee who make these decisions believe that rates will be 1% higher in a year's time. The dot-plot, you'll remember, is the chart upon which each individual member anonymously maps his or her predictions for the course of interest rates. Frankly, this tool has a chequered recent history and opinions vary as to whether it really is as helpful as it was intended to be. But taking it at face value for a moment, does that mean we should expect quarterly 25bp hikes in 2016 ? If so, we are presumably about to go through this whole palaver again in March ..... maybe that's the reason why the dollar has caught a bit of a bid.

In historical terms, one percentage point in a year hardly classifies as aggressive monetary tightening, but then again tightening cycles have never started form a near-zero base and against such a delicate global backdrop. Whatever the case, the markets are not convinced and Fed Funds Futures point to rates being 75bp higher at the end of 2016. Actually, and it's hard to tell how representative a selection it was, but it was remarkable how many of the talking heads on various financial TV channels this morning were less bullish than that. It's even being suggested that the best thing about yesterday's hike is that it gives the Fed some room (not much) to bring rates down again if they need to .... a sobering thought if ever there was one. Fortunately, no one is obliged to be as bearish as that but it's sensible to remember that there are always bound to be very different views about where we're headed. At the very least, that phrase "data-dependent" is likely to assume ever more importance, and the hawks will be hoping that it's not in a bad way .....