Federal Reserve enables rally in global risk assets

Dubai - Rates expected to remain lower for longer, writes Matein Khalid

The Federal Reserve did not disappoint the financial markets after Janet Yellen's FOMC conference on Wednesday. The US central bank did not raise the overnight borrowing (or Fed Funds rate) to 0.5 per cent on the eve of the November election. This triggered a wild rally in the US stock market with the Dow Jones up 163 points, gold up to $1342 and oil to $46 (aggressive monetary tightening and a stronger dollar is the kiss of death for the yellow metal and black gold), a surge in the euro and emerging market currencies. Interest rates will remain lower for longer but how much longer? The Fed noted that the case for a 25 basis point rate hike in December has "strengthened" now that it has reached the limits of its dual mandate to maximise employment consistent with two per cent inflation.
However, all is not hunky dory in the citadel of US monetary policy on Constitution Avenue in Washington DC. Three FOMC members dissented and voted to hike rates immediately in September. On the other hand, the Federal Reserve has lowered its projections for the year end 2017 Fed Funds rate to one per cent and yearend 2018 to 1.9 per cent. This is the real reason the stock market surged, gold and oil rose, the US dollar fell and the Volatility Index plunged from 16 to 12. The shift in Bank of Japan's monetary strategy also reassured Wall Street that the world's top central banks do not want a sell-off in the stock and bond market while global economic growth is so fragile and world trade volumes are in a slump.
I usually avoid trying to handicap the hawk versus dove debate in the FOMC because it is impossible to predict the outcome of a monetary policy vote. Yet it is significant that Boston Fed Eric Rosengren dissented at and voted to raise rates in September. Rosengren has switched from dove to hawk, a camp that includes the presidents of the Kansas City, Cleveland and Dallas Federal Reserve banks. Money market futures in Chicago now predict a 52 per cent probability of a rate hike in December.
Janet Yellen refused to answer a question at the press conference about whether the Fed did not raise rates due to the uncertainty created by the US President election in November even though she had specifically cited Brexit as a reason not to raise rates in June. While the Federal Reserve tries to maintain its aura of political independence, the fact remains that government spending and taxation plans (a political data point!) hugely influence the monetary policy debate. A financial markets economist I respect argues that Janet Yellen has been unnerved by the rise in the London Interbank Offered Rate (LIBOR) in 2016 and the Senate hearings on the Wells Fargo banking scandal. A panic in the global interbank market and threats to break up the California firm that was the world's most valued megabank before the scandal broke are a clear recession threat to the US and global economy. Since a rise in LIBOR raises the borrowing rate on a home equity line of credits mortgages and business loans in the US, it acts as a de facto rate rise. This could easily be one reason why the Fed did not hike rates in September.
The Fed's decision to guide "lower for longer" interest rates and the Bank of Japan's new monetary stimulus is bullish for emerging market currencies and growth. European equities exposed to EM include Danone Airbus, LVMH and Daimler AG. High dividend US, European and Asian property trusts, telecoms and utilities will re-attract global investor flows. The US dollar will be pressured in October just as OPEC meets to discuss on output freeze. This means Brent crude could well rise above $50 and makes Total, BP and Shell irresistible to me - the Seven Sisters offer juicy dividends that will not be cut. At 18 times earnings, US equities are near Wall Street year end fair value targets near 2175. This means the hottest equities action in the global markets will be in emerging markets industrials, UK/French energy, Asian REIT's. Above all, Bank Muscat still trades at five times forward earnings and 0.68 times book value for the sultanate's ultimate "too big to fail" bank!