Breaking News
• The Fed hiked but the statement was about as cautious as they could make it. Only gradual increases good enough for equities.
• The dot plot points to 4 hikes in 2016 and 17. Fixed income markets say less. For equities the key is that growth continues.
• European equity markets have bounced off Monday's lows and we think they are good value going into 2016.
* Yellen pulls the trigger but is going to move carefully
We said in our note on Monday that it was more important for equity markets what
Yellen said than what she did. A rate hike was baked in. For equity markets the concern
was all about the pace of tightening. By tweaking the language in the statement the Fed
told us they were going to be careful and they particularly highlighted the “shortfall of
inflation from 2%”. They said “economic conditions will evolve in a manner that will
warrant only gradual increases in the federal funds rate”.
* The Fed says 4 hikes next year, the markets say less
Fed expectations of future rate hikes were little changed, with the “dot plot” showing 4
hikes in both 2016 and 2017. The fixed income markets think the Fed will tighten less,
with two hikes priced for each year instead. Our economists are somewhere in between.
Fixed income markets did sell off modestly on the move, with 2 year yields up around
3.5bp at the time of writing. That is pretty modest in the context of this being the first
Fed hike in almost a decade.
* For equities gradual is fine if growth continues
For equity markets gradual tightening by the Fed is ok providing growth continues. So if
the Fed is right and growth continues to be reasonably solid then that is normally not a
problem for equity markets. Indeed, they tend to continue to perform well in the initial
stages of Fed tightening. It only becomes a problem for equities if it looks like the
tightening is starting to threaten growth.
* European equities off their lows and look good value
In our note on Monday we said European markets were getting oversold and we would
be buyers on further weakness. Post a further sharp sell-off on Monday, which seemed
to be triggered by concerns about the US high yield market, European equities bounced
strongly. Whilst there are concerns about US high yield and low oil prices, we think the
former is idiosyncratic rather than systemic and the latter eventually good news as it
supports growth. As such we believe the recent pullback leaves European equities
attractively valued going into 2016. They continue to offer attractive yield in comparison
with other asset classes, the ECB is expected to keep monetary policy easy throughout
2016 and European growth should continue to improve. That is not a bad combination
for the asset class.