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Market Update

Fed Reaction: No Action Today But December Hike Could Happen

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October 28, 2015

As expected, the Federal Reserve took no action on interest rates Wednesday, delaying the first rate hike since 2006 for at least another month-plus. The Fed did signal the possibility of a December hike in its brief statement, opening the door to heightened stock volatility as traders try to guess how quickly the Fed may have to respond.

Stocks remained higher but pared gains and turned choppy as traders digested the short release word by word for clues on future action. The S&P 500 (SPX) has staged an October rebound, with a few pauses, from last quarter—which was its worst in four years. The dollar gained after the Fed announcement, while benchmark Treasury yields edged up.

The CME Group’s FedWatch Tool, calculated based on pricing in the Fed funds futures market, shows traders are now pricing in about a 47% shot for a rate hike in December—up from 35% priced in earlier this week—and a 69% chance for a hike in March.

Temporary Conditions?

In its statement, the Fed noted slower but promising job growth, low inflation, and weaker energy prices. It said it’s watching global developments: “The Committee expects that, with appropriate policy accommodation, economic activity will expand at a moderate pace, with labor market indicators continuing to move toward levels the Committee judges consistent with its dual mandate [of max employment and price stability].”

The Fed emphasized its belief that it can move slowly once it acts: “The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run.”

The lone dissent came from known hawk Jeffrey Lacker, who wanted a quarter-point hike now. Fed Chair Janet Yellen is not scheduled to deliver a press release after this meeting and the Fed was not due to revamp its economic forecasts this go-around.

SPX-stock-chart

FIGURE 1: TWO-MONTH HIGHS.

The S&P 500 (SPX), charted on the new-look thinkorswim® platform, was knocking around at two-month highs in the immediate lead up to the Fed statement release. Data source: Standard & Poor’s. For illustrative purposes only. Past performance does not guarantee future results.

Global Impact

The U.S. and global economies have shown signs of slowing in recent weeks, challenging the timing of what was once seen as a gradual return to “normal” U.S. interest rates without a lot of surprises. But the Fed, in trying to let financial markets down easy, has been inviting confusion. Indications for higher rates and tighter money supply could spook Wall Street if too many investors think the Fed risks overshooting.  

After all, some argue, inflation is so close to zero it could turn into deflation. No-traction inflation perplexes the Fed and many of its central bank brethren. In fact, just this week Sweden’s central bank stepped up quantitative easing to keep pace with euro-zone stimulus, while a European Central Bank official reiterated the belief that further measures may be needed to revive pricing power.

The headline U.S. consumer price index (CPI) is near zero, and “core” or underlying inflation—a measure that’s stripped of volatile food and energy inputs—remains significantly below the Fed’s 2% target. That’s ammo for Fed doves but leaves the hawks nervous that inflation incognito is bubbling below the surface, or could be, as soon as full employment returns. And when it does, the hawks will contend, interest rate changes could have to come more aggressively than the Fed, and markets, would like.

TD-Ameritrade-Fed-Impact

FIGURE 2: BRUSH UP.

It’s been a while since the U.S. was in a rate-hike cycle. Investors and consumers may need to refresh their understanding of interest rate changes and the impact on markets and the economy to get ready for that day, whenever that might be, that the Fed raises rates. For illustrative purposes only. Past performance does not guarantee future results.

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