Fed Ripple Effect

This past week was focused on central bank meetings for the US and Japan. In the US, very few people believed the Federal Reserve Board (FRB) was going to raise rates this month… They did not disappoint!

Markets rallied across the board following the FRB decision to hold pat at .5%. The ripple effect the FRB had across the market was substantial. So much so, that it is worth reviewing how much FRB behavior impacts markets.

The Ripple
When the FRB leaves rates unchanged, we get a weaker dollar. The FRB is leaving rates unchanged because the US economy is not strong enough to warrant a rate hike. The key there is that the US economy is still showing weakness, which the prospect of this causes the dollar to weaken and gives me heartburn…

With a weaker dollar comes higher oil prices. Oil is priced in dollars so internationally the price of oil goes up as the dollar falls. This happens regardless of supply and demand, but as a bi-product of currency movement. It does not hurt any that Saudi Arabia was willing to negotiate production cuts in exchange for Iran placing caps on production. No deal was announced, but the prospect helped matters. West Texas Crude increased from $42.80 to $46.25 on the week[1].

In addition to oil gains, international equities perform for US investors even if stock prices do not move up. The weaker dollar increases the international value of equity positions when purchased in its local currency.

Of course, there is the domestic effect. When the FRB does not increase rates, they are effectively leaving monetary policy loose. US equities rally on the continued easy money in the short run.

Real Estate
Data out of the real estate sector was lack luster during its first week as an independent sector of the S&P 500. Building permits fell -0.4% when they were expected to expand 2.5%. Housing starts fell -5.8% when they were expected to contract -1.7%. Existing homes sales contracted -0.9% after a 1.1% increase was expected[2]. Even with all the soft data real estate seemed to take the data in stride. Mainly two reasons:

  • As a sector REIT’s benefit from low rates as their dividends will outpace the income produced by bond most bond markets.
  • While the data appears soft, inventories sit at a 4.6-month supply while 6-month supplies are viewed as equilibrium for supply and demand.

 

Conclusion
Markets have responded well to the initial ripple effect caused by the FRB meeting. The issue that may persist is the realization of why the FRB did not raise rates… A soft economic environment does not necessarily bode well for the economy.

 

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Always remember that while this is a week in review, this does not trigger or relate to trading activity on your account with Financial Future Services. Broad diversification across several asset classes with a long term holding strategy is the best strategy in any market environment.

Any and all third-party posts or responses to this blog do not reflect the views of the firm and have not been reviewed by the firm for completeness or accuracy.

 

[1] www.mfs.com – week in review

[2] www.investing.com – economic calendar

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