Investors Turn Focus to Global Economy After Fed Rate Move

http://www.wsj.com/articles/investors-turn-focus-to-global-economy-after-fed-rate-move-1450311484

Investors Turn Focus to Global Economy After Fed Rate Move 

Many are concerned about how markets will react as U.S. monetary policy diverges from that of other large economies

By Carolyn Cui, Min Zeng and Dan Strumpf 

 

Dec. 16, 2015 7:18 p.m. ET 

 

  

The Federal Reserve interest-rate increase leaves unaddressed two riddles vexing investors: How healthy is the global economy, and how will markets react as U.S. monetary policy diverges from that of other large economies?

Many traders greeted Wednesday’s decision with a sense of relief, as a long promised step toward the normalization of the markets and the U.S. economy. Market action was orderly, with portfolio managers and traders embracing a move for which investors had nearly two months to prepare.

The Fed did a masterful job preparing markets for the announcement, said  Jason Ware, chief investment officer at Albion Financial Group. “Looking at most market prices, there’s no bloodletting anywhere. It’s pretty smooth.”

The Dow Jones Industrial Average surged 250 points following the decision to raise the benchmark interest rate, the first since 2006, while Treasury bonds were largely flat and industrial commodity prices continued to slump. U.S. junk-bond prices rallied for a second day, as mutual funds and others continued to hunt for bargains following a two-week-long rout. The Dow industrials ended the day up 224.18 points, or 1.3%, to 17749.09.

The reaction, as well as the muted response to the Fed’s rate projections accompanying the announcement, underscores the widely held expectation on Wall Street that the U.S. economy will likely continue to expand next year, while the central bank gradually increases the federal-funds rate following seven years near zero.

Many analysts expect U.S. stock indexes to rise next year after a flat performance in 2015 and bond prices to decline only modestly, sending corporate and consumer borrowing costs somewhat higher as U.S. growth picks up.

Some analysts said they expect the volatility that has swept stocks, bonds and other assets in recent weeks to slow down as many financial firms cut back on trading during the holiday period.

Yet few investors expect any calm to hold long into the new year, given the large swings in financial markets over the past few weeks and the numerous question marks over the global economy.

Energy prices have hit lows not seen in years, the U.S. junk-bond market has suffered its sharpest declines since 2011, and China’s currency has posted its largest drop since the summer as the world’s most populous nation prepares to move its currency away from a dollar peg that has been in effect for years.

Many developing economies appear vulnerable to a bout of renewed dollar strength, which would increase borrowing costs at a time when growth is already weak. Market turmoil tied to China’s currency and Europe’s monetary easing highlights the sense that global markets are dependent on stimulus measures.

The European Central Bank has undertaken a €60 billion ($66 billion) a month bond-buying program and cut interest rates to boost the eurozone economy. The  Bank of Japan  also has implemented monetary-easing measures, as well as structural overhauls, to spur growth. In China, the central bank is instituting easing measures as well.

In the U.S., the developed economy with the strongest growth in recent years, there is concern that weakness from around the globe could spill over at a time when financing is becoming tighter for lower-rated companies.

Fed Chairwoman  Janet Yellen emphasized Wednesday that she expected the central bank would raise short-term interest rates gradually in coming months. Many investors said the central bank can’t be too judicious.

“The Fed needs to be careful not to undermine the U.S. growth momentum,’’ said James Camp, head of fixed income at Eagle Asset Management, which had $30.6 billion of assets under management at the end of September. Mr. Camp said he has scooped up long-term Treasury debt in recent weeks, moving cash from riskier corporate debt holdings.

Many investors are keeping an eye on emerging-market investments, which suffered large losses this past summer and still appear vulnerable. Brazil was downgraded by Fitch Ratings on Wednesday, and the South African currency this month hit a low against the dollar.

Among the concerns in emerging markets: retaining foreign capital at a time of slowing growth and substantial debt. Large investor outflows from emerging markets over the past few months have pushed down the monthly flow average to $5.7 billion this year, compared with $22 billion from 2010 to 2014, according to the Institute of International Finance.

Emerging-market currencies as a group are down 18% against the dollar this year through last week. Stocks, which are priced in local currencies, were down 17%. Dollar-denominated bonds have fared better, managing single-digit-percentage gains this year.

The scale of selling this year in emerging markets, U.S. junk bonds and other hard-hit asset classes may help to explain the broadly placid reaction to Wednesday’s decision, analysts said. “Given how much [emerging-market] currencies have already fallen this year, we don’t expect much turmoil in the near term,” said  Jorge Mariscal, chief investment officer of emerging markets at UBS Wealth Management, which oversees $1.9 trillion in assets. “What matters is the path of the interest rates in the U.S. going forward,” he said.

UBS said it expects four more rate increases next year, which will be problematic for some emerging countries, including Brazil, Turkey, South Africa and Indonesia.

Write to Carolyn Cui at carolyn.cui@wsj.com, Min Zeng at min.zeng@wsj.com and Dan Strumpf at daniel.strumpf@wsj.com 

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http://www.wsj.com/articles/fed-updates-details-of-rate-rise-tools-boosts-size-of-reverse-repos-1450292842

Fed Bolsters Tool Kit for Lifting Interest Rates

Central bank boosts potential size of reverse repo program designed to put a floor underneath short-term rates

By MICHAEL S. DERBY and  KATY BURNE

Updated Dec. 16, 2015 5:26 p.m. ET

3 COMMENTS

WASHINGTON—The Federal Reserve said on Wednesday it is boosting the size of a program it will use to set a floor under short-term interest rates as part of its effort to increase the cost of borrowing in the U.S. economy.

The Fed announced the move after a meeting where it decided to lift short-term interest rates off the near-zero levels they have rested since the end of 2008. The Fed also updated other details of the mechanics it will use to boost borrowing costs.

Most notably, the Fed said it was lifting the daily cap on its reverse repurchase program to around $2 trillion, from its current $300 billion. The change represents the most the central bank can do on that front, given that the cap is tied to the amount of Treasurys the Fed currently has available for the program.

“They don’t want to be at day one of liftoff where things don’t trade in the range,” said Zoltan Pozsar, a strategist at Credit Suisse Group.

The decision on the terms of the reverse repo program comes as part of a central-bank effort to put into play a new and largely untested set of tools for influencing borrowing costs throughout the U.S. economy.

The Fed said Wednesday it would raise the target range for its benchmark federal-funds rate by a quarter percentage point, to 0.25% to 0.50%. It plans to use two interest rates to set the upper and lower bounds of the range.

The Fed will seek to set the upper level of the range by raising the interest rate it pays deposit-taking banks on the money, called reserves, they park overnight at the central bank. The so-called IOER rate will be lifted to 0.50% from 0.25%.

It will try to set the lower bound, or a floor under short-term rates, with the interest rate it pays institutions like money-market funds on the reverse repurchase agreements. Through the program, the Fed borrows money overnight in exchange for Treasurys owned by the central bank. It will raise the repo rate to 0.25% from 0.05%.

Using these tools, the Fed will seek to drain money from the financial system, moving rates higher to prevent the economy from overheating. Fed officials are raising rates not to slow growth, but to reduce the amount of stimulus they are providing.

The Fed said the total size of the reverse repo program was determined by the amount of Treasury securities now owned by the central bank that would be available for reverse repos.

Ahead of the Fed’s decision, many traders had expected the Fed to raise the cap on the reverse repos to between $500 billion and $1 trillion, in part because the central bank had been ambiguous about how aggressively it wanted to use the tool. Some also have been concerned that an overly large program could distort the functioning of markets.

“The Fed is making it very clear they want to get interest rates up, so having this big reverse repo tool is the key to that,” said Ethan Harris, co-head of global economics at Bank of America Merrill Lynch.

David Kotok, chairman and chief investment officer at Cumberland Advisors, an asset manager overseeing $2.4 billion, said “markets liked it.” He said he was expecting the Fed to suspend the cap on the reverse repos.

The Fed didn’t say how long it will maintain the reverse repo’s new size, but officials in the past have suggested the reverse repo effort would be phased out over time.

The details laid out by the central bank represent a significant shift in how the central bank seeks to influence borrowing costs. In recent decades, the Fed adjusted the fed-funds rate—the rate on overnight loans between banks—by buying or selling Treasurys, which added or decreased the total amount of banks’ reserves. But the large amount of reserves added to the system since the crisis has made this approach less effective.

Fed officials believe their new tools will allow the central bank to control short-term rates.

The Fed didn’t comment on its long-run plans for its $4.5 trillion balance sheet. It said it would continue to use the proceeds of maturing securities to buy new bonds to keep the size of Fed holdings steady.

Write to Michael S. Derby at michael.derby@wsj.com and Katy Burne at katy.burne@wsj.com