Equities markets are impacted directly by the actions of the Federal Reserve Bank, especially with interest rate decisions.


The Fed Statement Causes Jitters with Investors!




On December 16, 2015, the Fed decided to break with a multi-year policy of maintaining low interest rates. That interest rates had not been raised since 2006 was notable; the Fed wanted to encourage economic expansion by facilitating the flow of money through the US economy while quantitative easing measures were in place. With trillions of dollars flooding the markets, economic activity increased during times of near-zero interest rates. Now, the federal funds rate is 0.50% and after the January 26/27 FOMC meeting, a Fed statement was released.

According to the fine print, the Fed would not rule out the possibility of a rate hike in March and would likely maintain its policy of gradual rate increases in 2016. The relationship between interest rates and equities is an interesting one; as interest rates rise (or speculators assume that they will rise) equities selloffs are commonplace. This is because interest-rate hikes affect companies in a negative way. For starters, higher interest rates mean that the costs of borrowed capital increase and this naturally gets filtered through to the consumer in the form of higher prices. It also means that dividends on stock payments are less and that profits will be affected. This results in the depreciation of stock prices.

We also know that during times of increased interest rates, US dollar appreciation takes place. This will make it relatively more attractive to purchase USD and sell foreign currencies. We can expect the US dollar index to appreciate in the run-up to the March meeting of the FOMC. Likewise, speculators will drive up the volatility index in equities (VIX) which in itself will be heavily traded as a hedge against falling equity prices. The S&P 500 index, the Dow Jones Industrial Average and the NASDAQ all sank when the Fed statement was released on Wednesday, 27 January 2016. Interest-rate hikes, or the possibility of interest-rate hikes, are not perceived positively by market participants. Two of the biggest stock declines reported were Boeing and Apple.

As goes January so goes the rest of the year

There is an old expression among investors: As goes January so goes the rest of the year and if January 2016 is anything to go by we are in for a rough ride yet. China weakness is pervasive with a 2015 GDP growth rate of 6.9%, with Q4 GDP for 2015 measured at 6.8%. This is the worst period in 25 years for China's GDP and it is impacting on the economies of emerging markets the world over. Weak commodity prices are being exacerbated by oversupply of iron ore, steel, crude oil, copper and the like. Slack demand, industry participants intent on securing market share above all else, and intentional currency manipulation by countries like China and other competing emerging market countries are having a detrimental effect on the market mechanism.

One of the most important correlations to be observed in recent weeks is that between crude oil and US equities. Equities have been closely tracking the movements of crude oil up and down. As crude oil prices increase, so equities gain confidence and increase accordingly, but the converse also holds true. In fact the relationship between equities and crude oil has overtaken actual company performance figures on the markets. When the Fed raised interest rates on December 16, 2015, it never anticipated that the effect would be as dire as it has been on global markets. Financial markets are in turmoil: the dollar has lost ground to major currencies, US economic performance has slowed, and China has gone into meltdown. While policymakers anticipate 4 rate hikes in 2016, traders in futures markets do not see things that way.

The Takeaway

The markets were looking for assurances from the Fed that the policy decisions that have been taken were the correct ones; instead what they got is uncertainty about the future direction of US economic policy vis-a-vis interest rates. Uncertainty leads to volatility, and volatility typically leads to selloffs – not a good sign for equities moving forward!


Author’s Bio: Brett Chatz is a graduate of the University of South Africa, and holds a Bachelor of Commerce degree, with Economics and Strategic management as his major subjects. Nowadays Brett contributes from his vast expertise for the globally renowned spread betting and CFD trading company – Intertrader.