The Temperature is just right for the US Federal Reserve to start the “rate increase flight”. With steady jobs growth, unemployment hovering at around 5% (the natural rate of unemployment in US), GDP growth at 2.1% (Q3 2015) these positive statistics warm up the interest rate freeze landscape sufficiently for “defrosting” action to start.
It is likely that Janet Yellen and her team at the Fed will hike the rate by 25basis point tonight. Yellen explained at previous meetings that delays in increasing the rate, might risk a more rapid and steeper increase in the future, such actions might push the global economy back into recession. While the markets were generally disapproving of the potential hike during the previous Fed meetings, the stock and options markets are generally accepting and expecting the interest rate take off now.
Risk of stimulants withdrawal
Visualise a body consuming a regular dose of stimulants, in this case historical low interest rate (Quantitative Easing) for a period of 6 years. The duration and regularity of the situation would normalise the initial stimulating effects. There is a possibility that when interest rate eventually take flight, the markets might experience withdrawal symptoms, although this scenario is unlikely to create too much havoc when the markets expects it.
Risk of Diverging paths / Opportunities of Convergence
Ruffle up your imagination again. Imagine someone on a pair of roller blades, each side (left and right) rolling on an individual track, a diverging track. At some point of the divergence, convergence has to happen, if not, the person will simply fall off and crash. While the US economy is on the upward trajectory, its global counterparts in Europe and Asia are still witnessing weak growth situation.
The positive scenario of convergence will be that the global economy gets pull up by the dynamic engine of the US. But if US gets drag back down, then it will be back to square one.
Gazing into the Crystal ball
The Fed has a dual mandate of checking inflation (price stability) and promoting maximum employment. While wage growth is showing healthy increase it is counter balance by the plummeting crude oil prices by more than half, hovering at around USD $40 now, there is little risk of inflation at the moment.
With the strength of the US economy and bargain oil prices, 2016 will likely be a good year for the markets. Commodities and Banking stocks should benefit from this landscape.
Photo & text by