Prior to last week’s announcement, investors had virtually dismissed the potential of a June rate rise. Indeed, some people inside the Fed were concerned that the market wasn’t taking the potential seriously enough.
But investors are now assigning odds of roughly one-in-three that tightening will resume in June.
In Australia 24 out of 25 economist believe that there will be a rate cut by August.
We continue to believe the Fed will raise rates by 25 basis points on two occasions this year, provided economic recovery and financial conditions remain stable. And we believe the case for acting in June remains strong.
Commodities, junk bonds and emerging markets have been benefiting from the belief that a US rate hike would not occur until later this year. And so it could be easy to get nervous about these markets if June goes ahead.
We are fairly relaxed about the global fallout of any Federal rate rise.
For a start, it would not be the first hike in this cycle – you will remember the Fed raised rates last December. Markets initially took this in their stride, although sentiment did deteriorate in January primarily due to worries about China.
And more broadly, there seems to be enough breathing space in the system. Take the US Dollar for example, which should go up if rates are increased in June. Normally, this would create problems for some markets:
- It could revive concerns about a devaluation of China's Renminb
- It could take some of the steam out of the rally in emerging markets, especially if accompanied by fresh falls in commodities.
But we are comfortable with China, which continues to show signs of recovery. The People’s Bank of China (PBOC) has also created wriggle room by allowing a small fall in their currency in trade-weighted terms this year.
The recovery in China should also support commodities, which in turn will benefit from stronger economic activity more broadly and increasing demand for inflation hedges like gold.
Meanwhile oil, which is still a key driver of equity markets, is looking stronger after Goldman Sachs' upbeat comments on the short-term outlook for crude helped drive Brent to a six-month high of $49.85 a barrel. Their comments highlighted recent supply disruptions and growing demand.
George Lucas is the managing director of Instreet Investment.
