Fed Clarity Spooks Markets
The
Federal Open Market Committee
delivered its expected 25-basis-point rate hike Tuesday, pushing the key rate to 2.75%. The move marked the seventh meeting in a row that the Fed raised rates by that amount.
The Fed's accompanying statement also contained the "measured pace" language, on which a lot of attention had been focused recently. Dropping the words would have been a clear sign that the Fed is prepared to hike in 50 basis-points increments on the road to bring rates to a less-accommodative range of 3%-4%. This time around, however, it was the words
around
"measured pace" that caused the market to stumble.
The
Dow Jones Industrial Average
plunged 94.88 points, or 0.9%, to 10,470.51 after being up about 40 points prior to the Fed announcement. The
S&P 500
fell 12.07 points, or 1.02%, to 1171.71, while the
Nasdaq Composite
lost 18.17 points, or 0.9%, to 1989.34.
In the fixed-income arena, the yield of the 10-year Treasury shot to 4.62%, an eight-month high, as prices fell 23/32.
The Fed
statement said that "pressures on inflation have picked up in recent months and pricing power is more evident."
The central bank also said that the risks to sustainable growth and price stability should remain balanced given "appropriate monetary policy action." In its Feb. 2 statement, the Fed had not mentioned that "appropriate" Fed action was necessary to bring about this balance.
In contrast to the FOMC's usual ambiguous language, Tuesday's statement was more forthcoming. The Fed aimed to convey that inflationary pressures now figure more prominently and that it is prepared to act more aggressively if conditions warrant.
"The tone is much more hawkish, and the undercurrent much more bearish for bonds," says Action Economics fixed-income analyst Kim Rupert, who sees a new range for the 10-year yield of 4.45% to 4.65% until the Fed next meets in May.
"The
FOMC members suggested that they're not going to be sitting on their hands any time soon," Rupert says. "The 'measured pace' will go out the window in May and there's more risk of a 50-basis-point rate hike sometime soon."
Instead of relieving itself from the measured pace verbiage, the Fed used the carefully crafted statement as a "stepping stone" to give itself flexibility while showing that it remains "ahead of the curve" on inflation, says Ashraf Laidi, chief currency analyst at MG Financial Group.
Corporate credit spreads also widened as more worries surfaced about
General Motors'
(GM) - Get Report
situation. A press report originally said that
General Electric
(GE) - Get Report
commercial finance unit had pulled out of a $2 billion loan agreement used to pay the automaker's suppliers. The two companies then clarified that the report was old news. But it reminded the market about GM's profit warning last week, which shook the corporate debt arena, and led some to believe the market has been too easy with money. GM still fell 0.5% to 29.54.
The Fed's comments Tuesday also boosted the dollar against the euro and the yen, continuing its recent upswing. The rising buck continued to encourage a move out of commodities, which are dollar-denominated. The CRB index dipped 0.47% to 313.02.
Crude oil also dropped below $56 a barrel, as a higher dollar makes oil more expensive, and after Saudi Arabia pledged to boost production to meet the world's demand.
The prospect of higher rates has put the greenback's issues -- the gaping U.S. deficits and central banks considering diversifying their reserves -- on the backburner for now. The Fed is expected to bring its key rate to between 3%-4% this year, and possibly higher next year depending on economic conditions.
That compares well with eurozone rates of 2%, Canada's 2.5% and Japan's 0.15%. Higher U.S. rates also reduce the gap with higher-yield countries, such as the U.K., with 4.75% and Australia, with 5.5%.
Of course, how far and how quickly the Fed will continue to raise rates will depend on economic conditions going forward.
Ahead of the Fed announcement, the producer price index, which had jumped an unexpected 0.8% in January, rose by a modest 0.4% in February, only slightly above market expectations for a 0.3% gain. Excluding food and energy, the PPI rose 0.1%, in line with expectations. However, on a year-over-year basis, the core rate is up 2.8%, the strongest rise since November 1995.
The February consumer price index report will be released Wednesday. In its statement, the Fed said it had seen no indication that energy prices were impacting consumer prices yet, perhaps a preview of the CPI from which economists are expecting a gain of 0.3% and 0.2%, excluding food and energy.
Also on tap Wednesday are the existing-home sales data for February. Given suspicions the Fed's tightening is aimed at cooling off the housing market as much as anything else, the report might prove more important than the consumer inflation data.
In keeping with TSC's editorial policy, Godt doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send
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