This Week's Focus: The dilemma of the Fed

This Week's Focus: The dilemma of the Fed


The 16th and September 17th the Open Market Committee of the US Federal Reserve will meet to decide the level of interest rate that applies to federal funds. Analysts are divided over whether it will be at its September meeting in December or the beginning of the process of normalization of US monetary policy, initiating a process of gradual interest rate rise. Some even suggests that it could be in October, surprisingly, in a meeting that does not have a press conference and would not be, a priori, decision-making on rates.

End of zero rates?
Since the financial crisis of 2008, the US official rates have remained virtually at zero level, seeking to stimulate economic growth. This stage, which was marked both by the use of unorthodox measures (the interest rate decreases) as unorthodox (quantitative easing), has returned to the US economy to the path of growth and full employment without generating for now inflationary pressures on prices.

However, some critics with the duration of this ultralaxa monetary policy, argue that greater evils may cause medium to long term solutions contributed in the short term. Specifically, the misallocation of resources, worsening productivity and bubble generation financial.

A very clear example is the evolution that has taken the bond market, where the relationship between risk and return has been losing meaning as demand for bonds grew well above the offer for reissue.

No inflation in consumer prices, the prices of financial assets are inflated
It is no coincidence that the ultra expansionary policy has caused a rising stock market since March 2009. Probably this was one of the objectives sought for a population whose savings are invested largely in equities. The wealth effect generated by a stock market higher, although wages and employment will remain depressed, has positive effects on consumption, and therefore in GDP. Unfortunately, it generates less propensity to save long-term.

When the market goes "behind" the Fed
In 2013, the then president of the Federal Reserve, Ben Bernanke, caused volatility in bond markets by announcing the possibility to stop intervening in it, in what became known as "Taper Tantrum". At that time, the market reacted by "before the Fed," causing strong movements in bond prices, with significant price drops passing rate on the benchmark 10-year 1.7% to 2.9%. The sharp rise in American interest rate bonus, just to finish the expectations purchase program, was a warning of what might happen in the future. Subsequently, the Fed announced an extension of quantitative easing (QE3).

The dilemma for the Fed going to please or surprise the financial markets. Currently, the interest rate futures curve underestimate American standardization of types that could hold the Fed. Thus, UBS forecasts that handles the rates implied market one year would be 0.75% lower than the entity expects to happen.

Likely effects of raising rates now
It is this market environment, so a rise in imminent guys like a speech that highlighted the monetary normalization based on similar patterns to previous cycles, could result in an adjustment of expectations for bond yields to rise, with consequent correction in prices fixed income in most periods. Given the low levels of performance we left, and the negative effect of the duration of the bonds would imply negative returns for investors in US fixed income.

The other bond markets, by its correlation with the American market, also suffer contagion adjustments, but smaller, unless emerging countries with debt in USD that would notice the effects even more so than the US.

Furthermore, although the positive signal that would send the market is the sustained recovery of the US economy, most likely in the short term, equities would suffer a fall due to lower valuation by increasing the discount rate of benefits future in the "fair-value". Our estimate is that the S & P 500 index pass the 2202 current theoretical value points to the range of 1760 to 1956 depending on the setting in the expected growth rate of corporate profits.

What if there are no changes yet?
On the contrary, if not now nor bias types are altered, arguing factors that can destabilize economic growth, a slowdown in China's economy, a new episode of Greek tragedy or a "currency war" between countries Emerging Asia, for example, markets may react negatively.

The feeling that quantitative easing has done little except to increase the debt of some countries, and the realization of economic growth was below potential (what has been called "the new normal"), may involve lower growth expectations and corporate profits, and favor a decline in equities.

In this environment of lower growth, debt sustainability of some countries and companies could be compromised, which could also generate negative cash flows from fixed income affecting prices and rising, effectively, interest rates.

In any event, the 17th will leave doubts.