The market’s reassessment of the Fed’s rate hike probabilities in December could have a significant impact on other asset classes except foreign exchange. The strengthening of the US dollar of course is the consequence that sticks out, but what about bonds? Stocks? Commodities? Emerging markets?
Starting with the easy one, of course the rate hike looks like a negative for bonds as prices go down when yields (or interest rates) rise. However, for bonds with longer maturities, the question is whether the Fed is now going to embark on a new campaign to raise interest rates and where such a campaign will stop. This will probably be the question that markets will turn to right after what looks like to be a rate hike in December. If the US economy starts to weaken soon after the rate hike, it’s possible that bond yields could head back down again. So this will largely depend on the future economic outlook as well as what the Fed will consider as a neutral rate target in the long-run. Other things being equal however, an earlier first rate hike will result in higher bond yields compared to the previous situation that rates were at zero. Inflation developments and expectations also have a big impact on bonds.
The influence of the first rate hike on stocks however is less clear. Stocks have been on an uptrend since 2009 in a very strong bull market. On the one hand rising interest rates should coincide with a stronger economy and rising corporate profitability, which in turn should lead to an even higher stock market. On the other hand, it is widely known that assets such as stocks have benefitted greatly from zero interest rates and quantitative easing and any rollback of monetary stimulus could make it harder for stocks to continue to advance. On balance, a string of interest rate increases should make it more difficult for the stock market rally to continue.
Moving on to commodities, many commodities are in a bear market as a result of slowing economic growth across the globe and particularly in China. According to organizations that monitor the world’s economy such as the International Monetary Fund and the OECD, there doesn’t appear to be much scope for faster growth in the quarters ahead. Furthermore, commodities are almost all denominated in US dollars and the higher the dollar, again other things being equal, the lower commodity prices should be. Therefore commodity prices should remain under pressure if the US dollar continues to strengthen. There can be other factors of course that are much more significant for individual commodity markets than the value of the dollar therefore care should be taken when generalizations are made.
Similarly the rate hike in the United States should have a negative effect on emerging market economies. Many emerging economies have built up external debt denominated in dollars in the aftermath of the global financial crisis and such debt will be harder to service if dollar interest rates are no longer zero and the dollar has at the same increased in value. Furthermore, emerging economies are often commodity producers or exporters of manufactured goods and a global economic slowdown can hurt them.
To sum up, US monetary policy is likely to have a big impact across various financial markets as it is now shifting to a less accommodative stance. This will be a topic that will preoccupy traders and investors across many different asset classes and different financial markets.
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