Thankfully at 6am this morning Sydney time, they did and the markets, led by Wall St, reacted the right way.
After 2,566 days of Zero Interest Rate Policy (ZIRP) we finally have US cash rate “lift off”.
In a unanimous decision, and 3,459 days since their last rate hike, the Federal Reserve raised its benchmark interest rate from near zero and importantly emphasised a gradual approach to future rate increases.
The Federal Open Market Committee (FOMC) raised the federal funds rate by a quarter percentage point to a range of 0.25% to 0.5%.
“The [Fed] expects economic conditions will evolve in a manner that will warrant only gradual increases in the fed funds rate,” according to the FOMC statement. To emphasise that gradualist approach officials later stated that they anticipate “gradual adjustments” in rates going forward.
New “dot” projections showed officials expect the benchmark rate to rise to 1.375% by the end of 2016, to 2.375% by the end of 2017 and 3.25% in three years.
Importantly that is a slower pace than projected by officials in September. Back then seven Fed officials believed the fed funds rate could rise to 3% or higher by 2017; now just four are of that view. The Fed said it would “carefully monitor” actual and expected progress toward the [inflation] goal. “There has been considerable improvement in the labor market,” the Fed said. The Fed also raised the rate it charges banks on emergency loans, by a quarter percentage point to 1%.
That is classic “dovish hike” speak and that is why Wall St liked it.
To quote from my SSR article last week:
“I believe the Fed will embark on a “dovish hike”. They are right to be keen to get away from 0% cash rates, but they also don’t want to undo all their heavy lifting of the last decade by having markets fear that rates are going to rise quickly.
My very strong view is they will accompany the rate hike with VERY dovish commentary. I have been highly critical of the Fed’s mixed messages this year and its absolutely crucial to all of us they get the wording exactly right that accompanies the rate rise and will set market expectations from that point.
In my opinion they will attempt to guide to very “gradual”, “data dependent”, “patient” rate rises in the future. The markets may even believe its “one and done” and if that happens there will be some very tradeable price action in anything US Dollar denominated.
We need to put in context that the markets are now fully discounting in a 25 rate rise. What they aren’t pricing in is the reaction to the “dovish” commentary I expect.”
What was most interesting was watching Wall St’s reaction this morning to the widely expected hike. The entire world expected the hike this morning, but as I wrote last week (above), the market reaction would all come down to the wording of the Fed’s statement and Janet Yellen’s press conference.
The initial reaction to the 6am rate hike confirmation was somewhat underwhelming. US equity futures rose a fraction and bond yields rose a fraction. However, from 6.30am when Yellen addressed the press US equity futures moved sharply higher as investors reacted positively to her words.
Most interestingly, Wall St was led by yield based equity sectors such as REITS, Utilities and Financials. This is a clear reaction to the Fed’s dovish tone and investors reacted positively that interest rate rises will be measured and the era of ultra- low interest rates is far from over. On that basis the so called “yield trade” is far from dead and equity investors searched for yield in equities while debt investors even bid up the recently beaten up US Junk Bond market.
I can’t stress enough how important the markets reassessing the pace of future Fed rate rises is. It means investors will still find no real yield in cash for many years yet. That is the key point. If you need investment income cash is still going to yield negative real.
Interestingly, yield sectors including Australian banks, Australian REITS and Telstra (TLS) have been de-rated in the six months leading into the Fed hike. I think those sectors have seen their worst and the world will once again seek the reliable dividend yield in these sectors in the months ahead.
The other clear point is the dovish Fed may well take some heat out of the mighty US Dollar in the short-term. You saw, as I forecast, the US Dollar Index (DXY) fell on confirmation of the hike and the Australian Dollar and other commodity currencies are up despite Oil being down on inventory issues again.
As I wrote last week,
The world, led by markets, are very ready for the rate rise. The US Dollar is up +23% in a year, commodities denominated in USD have been crushed, emerging markets have been crushed, emerging market currencies have been crushed, and as we all know, commodity currencies have been crushed. Yield based equity sectors have started to underperform globally.
In the way I approach markets the rate hike is a “known known”: the market reaction to it is the “unknown unknown” that professional investors like myself have to get broadly more right than wrong.
To confirm markets are now positioned for the “known known” of “lift off”, independent global macro research house Vanda Securities who analyses overall investor positioning, published the following chart this week.
What this table tells you is investors are over 1.5 standard deviations long the USD, and 1.5 standard deviations underweight/short pretty much anything else denominated in USD.
This is highly believable because investors have had so much time to get ready for this event, “lift off”.
What could easily happen on confirmation of “lift off” is a reversal in many of these very crowded positions, led by some profit taking in the mighty USD which in turn would trigger short-covering in commodity currencies, commodities and emerging markets.
I broadly believe Fed “lift off” is a positive event. It ends a year of uncertainty and shows confidence in the US economy’s self-sustaining growth profile. I also believe it paves the way for US equities to ADVANCE in late 2015 and into 2016, after Wall St’s global underperformance in 2015, driven primarily in my view by Fed uncertainty and the Fed’s previously woeful communications policy that in itself trigger volatility in risk asset markets.
What I expect to see from December 17th and onwards in the United States is a rotation from long bonds to equities. The long awaited “great rotation” from bonds to equities might just be trigged by the Fed’s “dovish hike”.
History suggests US equities continue to advance through the first four Fed rate hikes. I believe this will no different this time around and now we have “lift off” and end a year of uncertainty and volatility on a more positive and certain note. Markets like certainty that is one thing that is certain. You can see that this morning on Wall St.
While you know I am bullish on Australian equities around these 2.5 year index lows, and I expect a better total return from the ASX200 in 2016, for that to happen we need resources, but particularly BHP Billiton (BHP) to bottom out and start regaining a little ground.
I get endless questions on BHP, particularly since it fell below $20.00. The more the stock fell, the more questions I got. Fair enough, I don’t think anyone ever thought BHP would have a $16 in front of it.
BHP has suffered from a series of “unfortunate events”, the final one being the dam collapse.
However, I believe this is no different to three other deep value large cap situations I have been involved in my career, Telstra (TLS), Wesfarmers (WES) & Qantas (QAN).
At $2.80 in Telstra with the Future Fund dumping stock and the company in a fight with the government I called TLS “ a gift from the Nation”. I went on to be my best contrarian call ever. Similarly, with Wesfarmers getting creamed down to $15.00 after buying Coles I also aggressively recommended buying the stock. That one went onto triple and pay about $10.00 of divs along the way. In Qantas, I wrote a thesis at a $1.00 that you were “buying the airline for free” because the frequent flyer business was worth more than the enterprise value of the company at the time. Sure I also got a bit lucky with the oil price collapse in Qantas but the thesis about valuation and rational competition was correct. Qantas rallied +200% from that point.
The current BHP share price reminds so, so much of TLS, WES and QAN at the bottom. None of those made instant share price recoveries, but if you bought the nadir of pessimism you bought value and value was eventually released.
The way to approach these situation is to “have a nibble” and that’s exactly what I’ve done in the AIM Global High Conviction Fund in BHP Billiton. I just couldn’t resist the temptation below $17.00. Have I bought the bottom?? I can’t be sure of that, but I know I’ve bought value driven by extreme pessimism. That’s what I did in TLS, WES and QAN, and I’m confident this BHP situation is no different.
Just remember it’s always darkest before the dawn and right now in terms of BHP Billiton’s share price it is pitch black. If you want to do something in reaction to the Fed’s “dovish hike” I would suggest there are worse things to do than “have a nibble” in BHP shares around $17.00.
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