Japan and Europe will likely outperform when the US Fed loses its 'patience'
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MEMBERS of the Federal Open Market Committee (FOMC) were out in force recently to voice their support for a policy rate increase as the US labour market continues to improve.
According to the Federal Reserve’s chair, Janet Yellen, the US economy has now improved to a point where the setting of the Fed funds target rate will be determined on the “basis of incoming data”.
The likelihood of a rate increase will be reinforced if the FOMC deletes the promise to be “patient” with rate hikes at its March 17-18 meeting, which will signal that the first rate hike could come as early as June.
As markets adjust for a rate increase, the yield on 10-year US Treasuries reached bottom on January 30, at 1.64 per cent, and then rose by 50 basis points to the current level. The Dollar Index, the gauge of the US dollar exchange rate against its trade partners, has risen 9 per cent so far this year.
Even with the rapid adjustment in bond prices and exchange rates, the markets do not seem to be fully prepared for the rate hike. Fed funds futures are so far below the dot plot, which shows the Fed’s members expected path of interest rates.
The disconnect between FOMC members’ views and that of the market could result in market turbulence when the Fed abandons its commitment to zero interest rates.
A strong US dollar and rising US rates are negative for emerging-market assets and commodities, as evidenced by gold, which has dropped 10 per cent since this year’s peak in late January, erasing the early-year gain.
The Brazilian real and Turkish lira have weakened by 14 per cent and 8 per cent, respectively, against the US dollar.
US equities are also under pressure from a strong dollar. Foreign sales account for a third of total revenue, and a stronger dollar will translate to lower overseas revenue.
The S&P500 index has stayed flat year-to-date.
Volatility will increase as the Fed bolsters the signal for a rate hike, but an equity-market correction could offer an attractive buying opportunity.
In times of turbulence, Japanese and European equities could offer a haven from a strong US dollar, as a weak yen and euro help support earnings.
Technically speaking, the DAX, STOXX600 and Nikkei225 are trading with positive and rising correlation to the US dollar exchange rate, while the S&P500 and emerging economies’ stock markets – including the Stock Exchange of Thailand – are trading with negative correlations to the dollar.
Improving economic conditions and more reasonable stock-market valuations will also support these markets going forward.
Komsorn Prakobphol is head of strategy at Tisco Economic Strategy Unit. He can be reached via www.tiscowealth.com or [email protected]
