By Luis Aureliano

2017-03-12_0137The US economy is barreling full steam ahead, with jobless claims at multi-decade lows, unemployment holding steady at 4.8%, and inflation approaching the 2% differential. With that in mind, it makes sense that Fed heavyweights Janet Yellen and her vice chair Stanley Fischer are raring to go. In fact, Yellen was unequivocal in her statements recently:

‘… Given how close we are to meeting our statutory goals… The process of scaling back accommodation likely will not be as slow as it was in 2015 and 2016…’

Simply put, this means that the Fed is going to act sooner, rather than later. Based on the latest probability numbers from the CME Group, the chance of a 25-basis point rate hike on Wednesday, 15 March 2017 is now at 79.7%. This means that there is an overwhelming likelihood that the Fed will move to hike interest rates this month. This has far-reaching implications for the broader US economy, and the global economy.

How will Fed Policy Impact Markets?

Big league. The Fed is the world’s most important monetary authority. It is responsible for the US monetary policy and that includes interest rates. If the Fed decides to raise interest rates in March, this will have a direct effect on the USD. The greenback strengthens with rate hikes, and this affects all dollar-denominated commodities such as gold bullion, silver, copper, crude oil and the like.

Already, gold is taking strain from a likely Fed rate hike. We’ve seen the gold price slipping in 2017, despite maintaining positive gains for the year to date. Recall that in 2016, gold was a stellar performer, racking up gains of 20% + for Q1 and Q2, before reversing and becoming a lackluster commodity.

If we turn our attention to equities markets, things couldn’t be rosier. The S&P 500 index recently celebrated its 60th birthday. This is one of the most highly capitalized indexes in the world, with a market capitalization of around $2.3 trillion. The S&P 500 index differs from other indices in that it weights stocks by the number of shares outstanding and their share price. Therefore, companies with the same share price but vastly different numbers of shares will be weighted differently.

Why are Indices Rallying on the Back of a Possible Rate Hike?

There has been a sharp uptick in index trading since the election of Donald J. Trump. He has boosted consumer confidence, producer confidence, and the mood in the corporate sector. The Dow Jones Industrial Average broke through the critical 21,000 level, and is rising fast. Much the same is true of the NASDAQ and the S&P 500 index, all of which are trading at record levels. The same cannot be said of bourses across the Atlantic, what with the CAC40, DAX 30 and FTSE 100 index languishing in slow growth.

It is interesting to point out that indices on Wall Street are reacting favorably to the prospect of Fed rate hikes. The reason for this is clear: markets have beenexpecting the Fed to act. The size of a Fed rate hike is limited to just 25-basis points. While this is substantial for an economy the size of the US, it is not a dramatic rise. The Fed has made it clear that it favors a policy of gradual but modest increases to the federal funds rate.

Markets are pricing this in accordingly. Further, Trump’s fiscal stimulus measures are going to dovetail with Fed policy to accelerate economic growth prospects, infrastructure rebuilding and military refurbishment. If Congress passes legislation to approve expenditure, equities markets will rally further.

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