Whatever we said on 5 November came true. For the first time in 9 years, the Fed hiked the Fed Funds target interest rate by 25bp to 0.25-0.5%, ending an eon of zero lower ground rates and marking the start of a new paradigm. A paradigm that is, much as most would hate to admit, unprecedented in terms of scale and bredth.
As we approached 16 December, markets had increasingly discounted a Fed liftoff, but there was still some element of uncertainty. That uncertainty now shifts to what the Fed will do in 2016. Will it continue to gradually hike rates? Will it reverse on its path of monetary tightening and start to ease? These are but a multitude of questions that everyone is asking, but no one can really answer.
Markets are forward looking and are always factoring in expectancies of future events in pricing. What we're seeing so far seems to tell us that markets believe that any future rate hike will occur extremely slowly; with each increase being unevenly spaced out.
However, the question that beggars answering is if the Fed has made a policy error by hiking into a pretty extraordinary environment both inside the U.S., and globally. As mentioned earlier, we believe there is no set precedent for what we find ourselves in today. There are a few tightening cycles that come close to today's, but none are similar enough.
It was Ben Bernanke who slammed rates to zero and unleashed a torrent of liquidity via QE. Janet Yellen now has the arduous task of "normalizing" monetary policy from ground zero. As you would suspect, that isn't the easiest thing to do in the world. It's fair to say that there's a lot of weight placed on the current FOMC. They are playing with weights on a very fine balancing scale, and they've got to get it right.
Both camps are equally matched and honestly, we'd like to sit on the fence for now. We have included some graphics and captions from Bank of America, which does a nice job laying down the case of a policy mistake.
Bank of America Merrill Lynch on why the Fed was wrong hiking rates this week:
As Fed hikes rates for the first time in 3,460 days, officially ending the era of extreme, abnormal monetary policy in the form of QE and zero rates, what do we see?
As Fed hikes rates for the first time in 3,460 days, officially ending the era of extreme, abnormal monetary policy in the form of QE and zero rates, what do we see? Risk assets were very oversold going into the Fed hike... they now bounce.
But the Fed hike follows significant tightening of liquidity; negative blowback is more and more visible, e.g. credit crunch causing less stock buybacks.
And global banks being at all-time relative lows indicate Fed tightening into deflationary expansion, as does the narrow breadth of economic growth, wealth and asset price gains.
The Fed hiked 25bps, thus officially ending an unprecedented era of ZIRP and QE. Some quick thoughts: