The Fed surprised markets by turning the first rate hike in nine years into a relative nonevent for markets.
“I think the market pretty much had a lot of it built in. There were no surprises, which I think is a good thing. Now we can stop worrying about when we’re going to get a rate hike because we already had that now,” said Randy Frederick, managing director, trading and derivatives at Charles Schwab. “I’ve said I thought there was a good chance we could have a solid two week rally into the end of the year.”
The Fed had convinced markets that it would raise rates by a quarter at its December meeting and continue to deliver a relatively dovish message about the future path of rate hikes. It did both Wednesday afternoon, ending seven years of a near-zero fed funds rate.
“It took them long enough. It took from September to now to turn it into a non-event,” said John Briggs, head of strategy at RBS. The Fed surprised some in the markets when it held off on a rate hike in September because of concerns about financial conditions and international developments.
Fed Chair Janet Yellen Wednesday stressed continued focus on economic progress, including inflation, which is lagging the Fed’s 2 percent target. So the focus for markets remains the economic data. For Thursday’s trading, there is the weekly unemployment claims at 8:30 a.m. ET, and leading indicators and the Philadelphia Fed survey at 10 a.m. ET.
“It’s important not to over-blow the significance of this first move. It is only 25 basis points. If monetary policy remains accommodative, we have indicated that we will be watching what happens very carefully in the economy,” Yellen said during her press briefing. Yellen also said the Fed wanted to hike rates to avoid an overheated economy that could force it to raise too rapidly.
“She is in no hurry to ‘normalize’ rates. She’s raising them today because she’s afraid that if she doesn’t, she might have to act more aggressively at some point in the future. But she also made it very clear that she’s going to remain very accommodative for quite a while to come. Bottom line, we might be sitting at 25 basis points for a while. What does this mean? It means the dollar might give back some of its recent gains. All else equal, it’s also good for the markets broadly. The Fed isn’t taking away the punch bowl. It’s just putting a little less booze in it. All in all, this is probably the best outcome we could have hoped for,” said Charles Sizemore, principal of Sizemore Capital.
Stocks were initially mixed after Wednesday’s hike but rallied as Yellen spoke in a 2:30 p.m. ET briefing. The Dow was up 224 points at 17,749, and the S&P 500 was up 29 at 2073. The dollar index was barely changed. Treasury yields rose slightly, with the Fed-sensitive 2-year over 1 percent for the first time since 2010, and the 10-year yield at 2.29 percent.
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“Bravo to Yellen,” said Frederick. “She played her hand well. She did a lot of things right, like getting a unanimous vote. She left the door open for any kind of policy action at all next year. They could not raise rates for seven or eight months or they could raise in March.”
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All Federal Open Market Committee members voted in favor of the hike. The Fed also did not change its 2016 funds rate forecast, as anticipated by some in the bond market, so the market continues to price in three hikes next year versus the Fed’s forecast for four.
“It underscores the decisiveness of the decision. There have been three voting Fed members that were thought to likely dissent,” noted Marc Chandler, head of foreign exchange strategy at Brown Brothers Harriman.
David Ader, head of Treasury strategy at CRT Capital, said the Fed statement and Yellen’s comment were consistent with bond market expectations, and the market has been pricing in fewer hikes than the Fed.
“The Fed has been very consistently ahead, which would be more aggressive than the market. I think we heard full on what was expected,” he said. “We bought her rumor. We’ve been at least since Friday selling the fact.”
Earnings are expected Thursday from General Mills, Rite Aid, Actuant,Navistar, Sanderson Farms, Scholastic and Winnebago. Red Hat and Duluth report after the close.
The Fed also announced some operational details on how it plans to raise the fed funds rate. It said it would have no cap on the capacity it will have in its overnight reverse repo operation, a collateralized lending program. The facility was $300 billion, but Yellen said the Fed will temporarily remove the capt to guarantee the interest rate will stay at the new target.
Under the program, institutions lend cash in an overnight operation to the Fed at a certain rate, which would be 25 basis points, the low end of the new target rate range, in exchange for securities. The transaction is then reversed.
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