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Home > Blogs > Moorad Choudhry > FOMC and optimism: an uber-dove at the helm means markets are only going up in 2014

FOMC and optimism: an uber-dove at the helm means markets are only going up in 2014

FOMC and optimism: an uber-dove at the helm means markets are only going up in 2014 Moorad Choudhry

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Last week, a senior monetary policy committee member at the Bank of England (BoE) remarked that when interest rates start to rise it’s good news, because it means that the economy is growing at a pace that warrants action to reign it in, so to speak. That is 100% right. The UK economy has started to look quite positive as Q1 has progressed, and all the signs – unemployment, GDP growth estimate, retail sales, and house prices, to name a few – suggest that optimism is back. The Chancellor (Finance Minister to non-British readers) recently spoke about raising the minimum wage – and he’s from the right-wing Conservative party! So we're agreed that when the BoE does eventually start to raise rates - which I would expect towards the end of 2015 - it’s a sign for markets to push on.

Is it any different for the US economy? In theory, no. A rate rise from the Federal Reserve would be for the same reason: the central bank deciding that the economy was strong enough to withstand higher interest rates, thus suggesting it was on a sustainable growth path. And that would only come after starting to wind down quantitative easing (QE).

So why will a doveish statement from the forthcoming Federal Open Market Committee (FOMC) and its Chair, Ms Janet Yellen, trigger a further upward surge in equity markets? Because of the paradox that has been in place since 2008-09 of central banks and the public sector underpinning the private sector. Equity investors have never had it so good - when prices rise, they’re happy; and when prices fall, the central banks step in with zero rates and QE to raise prices again, and they’re happy. So “more of the same” at the forthcoming FOMC meeting this week means more stock market highs.

There is a more interesting twist to this FOMC meeting: what to do about the “forward guidance” part and the linkage to the level of unemployment. You don’t want to get me started on forward guidance, which to me lacks a certain robustness as a concept (and the linkage to unemployment is even more illogical), but we have what we have, and the Fed had previously cited a rate of 6.5% as their trigger point. But the US unemployment rate is now at 6.7% - so what to do?

Whatever the outcome, whether some re-alignment to a lower jobless rate or weakening of the linkage itself, both rates and QE are not going anywhere fast for now. So the markets can, and will, push on after the FOMC. The US Treasury curve should steepen in the 0-5 year area, but the long end will stay down so the curve will become more humped, as bond investors react to short-dated rates not moving for now, and rates rising in 2015-16.

One caveat of course, and that is Ukraine. If that stand-off gets warmer or turns hot, flight-to-quality will be back and we will have to start all over again. It would also extend the period when rates stay at zero and QE stays at current levels.

But in the meantime - come on in, the water’s lovely.


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Tags: Bank of England , BoE , equity investor , equity market , Federal Open Market Committee , FOMC , forward guidance , interest rates , Janet Yellen , QE , quantitative easing , Ukraine , unemployment , US Treasury
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