Fed increase 'would alarm'

Equities markets around the world could get a shock if the United States Federal Reserve opts to increase interest rates this week.

Monday, September 19th 2016, 6:00AM

by Susan Edmunds

Sharemarkets, including in New Zealand, had a volatile start to the week last week as it became obvious this week’s meeting is a “live” one – with the possibility of an interest rate rise on the table, albeit rated less likely than a December move.

Fergus McDonald, head of bonds and currency at Nikko, said the fact the market was expecting the move later in the year would mean any immediate change would have more of an impact and a move this week could cause alarm.

“If they do move, markets will be a lot more unsettled and we might see that reverberate around equities markets and the like.”

It would pull up long-term interest rates for New Zealand, too, he said.

Christian Hawkesby, executive director of Harbour Asset Management, said the meeting this week would probably include clear signals about the expected path of US interest rates, which could affect in the markets even in the absence of a rate change. “Markets are quite sensitive about this stuff at the moment.”

He said some investors had moved into equities as an alternative source of yield but now were thinking that markets were very expensive and valuations stretched.

But the yield environment could change if bond yields went up.

Graham Harman of Russell Investments said he was expecting a hike in December and two next year.

“It’s good news that the Fed is in a position to credibly raise rates now, despite some slightly softer data recently. The real disaster would have been if they had run with quantative easing and near-zero interest rates for seven years, if the economy had not responded, if they had been seen to have 'run out of bullets' and if the market had completely lost confidence in the Fed’s power. Enough economic recovery looks to have arrived, just in the nick of time to allow tightening – which is a positive outcome.”

But he said markets would still probably be unhappy with a September move.

“Emerging markets may feel some pain, as higher rates in the U.S. will likely lift the dollar and draw capital, draining it from elsewhere in the world. The energy sector might take a hit too, as the dollar is the single most important currency in the oil world and a stronger dollar typically drives oil values down.”

But McDonald said the Reserve Bank would be pleased to see an increase.

The Reserve Bank wants to get inflation up into its target band and the only way it can do that is by getting the Kiwi dollar lower. The only real way it can get the Kiwi dollar lower, in its opinion, is by cutting interest rates and making it less attractive for international investment to come into New Zealand financial markets. But if the US is relatively more attractive compared to New Zealand it would probably have the impact of a weakening Kiwi dollar against the US.”

Tags: equities interest rates