One dollar and 10 cents in Australian currency sit atop a U.S. one dollar note in this photo illustration taken in Sydney July 27, 2011.
One dollar and 10 cents in Australian currency sit atop a U.S. one dollar note in this photo illustration taken in Sydney July 27, 2011. Reuters/Tim Wimborne

The FOMC bringeth frankincense, myrrh and rate hikes

The beginning of the first Fed rate hiking cycle since 2004 began this morning (AEDT) as most had expected. The only uncertainty was what indications the statement and the press conference would give for the future path of rates. Judging by the dramatic moves in the dollar index in the wake of the decision, the FX markets are still trying to make their minds up about whether we have seen the cyclical peak in the US dollar or whether it still has further to go. Although at the current juncture the dollar index looks to have little inclination to break through the 100.51 level that it reached on 2 December.

What is clear is that equity markets are taking the rate hike as a positive. The S&P 500 rallied 1.5% and all the futures markets for the Asian session are looking to see markets open 1-2% higher across the board. If Asian markets do look to be holding their positive calls at the open, we could see the ASX moving over 5100 and possibly achieving 2% gains in back-to-back sessions.

The fact that the Fed were able to hike rates indicates that the US economy has finally developed enough upward momentum to withstand higher interest rates. The question for many investors now is whether this momentum in equity markets is likely to develop into a full blown “Santa Rally” through to the end of the year. With little further market moving releases expected over the coming weeks and a still dovish trajectory for future Fed policy there does seem to be a good chance of this happening. It is worth noting that historically 16 December has been the seasonal beginning of a “Santa Rally”, so its timing with the Fed meeting does seem particularly auspicious to bring some Christmas cheer to those with equity portfolio holdings.

Things in the energy sector are looking less positive as WTI oil dropped 4.5% in the wake of the blowout in EIA weekly oil inventories. US oil inventories grew by 4.8 million barrels against expectations for them to decline and refinery capacity utilisation rates also declined. Despite this the HYG high yield bond ETF still ended the day in positive territory, gaining 0.7% and bringing some calm to the high yield credit concerns. This has largely cancelled out the rally of the past few days driven by expectations for Congress to remove the ban on US oil exports. Gold and silver on the other hand, have been rallying as the future path of rate hikes by the Fed looks set to be “accommodative”.

Comments:

· The Fed dot plots left their expected trajectory for the Fed Funds rate at the end of 2016 unchanged at 1.4%. This would entail four rate hikes in 2016, but currently the market has only priced in expectations for 2.5 rate hikes in 2016. At the moment, the market does not appear too concerned, indicating a confidence that the Fed rates trajectory should become more in line with its own over the year.

· It is important to note that historically the second and third rate hike in the cycle have been more negative for equity markets. Based on the current WIRP bond market probability, the most likely next date for a rate hike is the Fed’s June 2016 meeting (65.8%). The WIRP is pricing in an 81.7% probability that rates will remain unchanged at the Fed’s January meeting, with a marginally higher likelihood given to a rate cut than a rate hike for January!

· Janet Yellen stated that strong domestic demand was cancelling out the negative contribution from net exports due to the strong US dollar. It may seem counter intuitive, but a “dovish hike” at the December meeting could quite likely be the best way to weaken the US dollar and in turn help the embattled US export sector. Uncertainty around the first Fed rate rise has now ended and markets do not believe another rate rise will happen until June - this is likely the perfect formula to see the USD weaken in the near term.

· One big unknown was seemingly put to rest in the Fed statement, which said that the runoff of the Fed’s balance sheet is not likely to begin until “normalization of the federal funds rate is well under way”. Fears of a rapid liquidation of the Fed’s balance sheet look unlikely to occur, and even a minor decline in the balance sheet may not be seen until after 2016.

Asian markets opening call

Price at 8:00am AEDT

Change from the Offical market close

Percentage Change

Australia 200 cash (ASX 200)

5,056.50

28

0.56%

Japan 225 (Nikkei)

19,327.20

277

1.46%

Hong Kong HS 50 cash (Hang Seng)

21,919.40

218

1.01%

China H-shares cash

9,646.20

108

1.13%

Singapore Blue Chip cash (MSCI Singapore)

320.35

2

0.68%

Futures Markets

Price at 8:00am AEDT

Change Since Australian Market Close

Percentage Change

Dow Jones Futures (December)

17,700.00

106.00

0.60%

S&P Futures (December)

2,066.50

15.75

0.77%

ASX SPI Futures (December)

5,057.50

30.00

0.58%

NKY 225 Futures (March)

19,362.50

315.00

1.65%

Key inputs for the upcoming Australian trading session (Change are from 16:00 AEDT )

Price at 8:00am AEDT

Change Since Australian Market Close

Percentage Change

AUD/USD

$0.7249

0.0045

0.62%

USD/JPY

¥121.855

-0.035

-0.03%

Rio Tinto Plc (London)

£19.12

0.33

1.74%

BHP Billiton Plc (London)

£7.06

0.19

2.72%

BHP Billiton Ltd. ADR (US) (AUD)

$16.91

-0.27

-1.55%

Commonwealth Bank ADR (US) (AUD)

$79.42

0.33

0.42%

Metals Exchanges (Change are from 16:00 AEDT )

Price at 8:00am AEDT

Change Since Australian Market Close

Percentage Change

Gold (spot)

$1,073.55

9.05

0.85%

Brent Crude (January)

$37.18

-1.07

-2.80%

Aluminium (London)

1492.5

15.00

1.02%

Copper (London)

4605

32.00

0.70%

Nickel (London)

8815

245.00

2.86%

Zinc (London)

1518.5

15.50

1.03%

Iron Ore (62%Fe Qingdao)

$39.13

-0.10

-0.25%

IG Iron Ore (CNH)

¥296.25

1.50

0.51%

IG provides round-the-clock CFD trading on currencies, indices and commodities. The levels quoted in this email are the latest tradeable price for each market. The net change for each market is referenced from the corresponding tradeable level at yesterday’s close of the ASX. These levels are specifically tailored for the Australian trader and take into account the 24hr nature of global markets.

Please contact IG if you require market commentary or the latest dealing price.

ANGUS NICHOLSON
Market Analyst
IG, Level 15, 55 Collins street, Melbourne VIC 3000
D: +610398601747 | T: +61398601711www.ig.com

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