The Fed's Powell: US Economic Growth Still Positive at a Healthy Level
The Fed's Governor Jerome Powell - Photo by Federal Reserves.

JAKARTA (TheInsiderStories) – The majority of Asian stock markets fell in early trading on Thursday (14/06), after the Federal Reserve (Fed) raised its benchmark rate by 25 bps to 1.75 percent to 2 percent. The decision marking the second hike of 2018.

Asian stock losses trailing Wall Street under pressure on Wednesday’s close. This morning, Nikkei 225 index slipped 0.71 percent, the Kospi index in South Korea fell 0.89 percent, and in Australia, the S & P/ASX 200 index edged up 0.03 percent after opening lower.

The central bank signaled that the rate hikes will rise faster this year as the decline in unemployment and inflation are close to the 2 percent target. Yields on 10-year U.S Treasury tenors broke through the 3 percent level after the Fed’s decision, though then moved down again.

Stock markets are however affected by interest rate changes, as an interest rate hike could trigger higher borrowing costs. The Fed’s factor is increasingly weighing on markets still worried about trade frictions between the United State and China.

The Federal Open Market Committee (FOMC) reported the information received by the board since met in May indicates that the labor market has continued to strengthen and that economic activity has been rising at a solid rate.

Job gains have been strong, on average, in recent months, and the unemployment rate has declined. Recent data suggest that growth of household spending has picked up, while business fixed investment has continued to grow strongly.

On a 12-month basis, both overall inflation and inflation for items other than food and energy have moved close to 2 percent. Indicators of longer-term inflation expectations are little changed, on balance.

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee expects that further gradual increases in the target range for the federal funds rate will be consistent with sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee’s symmetric 2 percent objective over the medium term. Risks to the economic outlook appear roughly balanced.

Furthermore the board said, the stance of monetary policy remains accommodative, thereby supporting strong labor market conditions and a sustained return to 2 percent inflation.

In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its maximum employment objective and its symmetric 2 percent inflation objective.

This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments.

Further investors around the world market attention will shift to the European Central Bank (ECB), which will decide on interest rate policy today. Although no changes are expected, investors are awaiting news of the planned bond-ending program.

Last May, the ECB left its key interest rate unchanged in the last governors meeting. The interest rates on the marginal lending facility and the deposit facility will remain unchanged at 0.00 percent, 0.25 percent and -0.40 percent respectively.

ECB’s President Mario Draghi expects the ECB key interest rates to remain at their present levels for an extended period of time, and well past the horizon of the net asset purchases. Furthermore, he said, the Governing Council will continue to monitor developments in the exchange rate and other financial conditions with regard to their possible implications for the inflation outlook.

Commenting on the U.S economy, Draghi saw the yield increase was to be expected for two reasons, the different position in the business cycle of U.S economy and recent measures concerning fiscal expansion.

ECB itself indicated that policy makers are prepared to begin setting the stage for the wind-down of its bond-buying program despite recent political turmoil in Italy. If the ECB holds off on laying out a timetable for QE exit, it could be taken as a sign of concern by policy makers about the economic outlook, which could be something of a negative for markets.

Mike Wilson, Morgan Stanley’s chief investment officer and chief U.S. equity strategist doesn’t think the sudden spike in volatility portends the start of a bear market.
Mike Wilson – Morgan Stanley

“I just want to remind people that in the last 12 months the S&P 500 went up 20 percent. It has had a heck of a run. It doesn’t surprise me that we have had a little volatility here.”

A correction is a market drop of at least 10 percent. On average, the market corrects 14 percent in a year; last year, the biggest correction was just 3 percent, says Wilson.

He added, “People get used to that. They start to count on that. So when volatility picks up, it can lead to forced selling.”

So far, Wilson says the bull market is clearly a mature one, but he doesn’t see signs that a bear market is approaching soon. Still, he is keeping a close eye on financial conditions.

Below are three signals he’s watching to stay ahead of a market shift:

  • If the yield, on the benchmark 10-year U.S. Treasury note rises to 3.25% or 3.50%, “that could cause a real problem,” he says. It’s now 2.8%.
  • If corporate bonds start to trade very poorly and credit spreads start to widen out. So far, “credit has traded weaker, but nothing significant,” he says.
  • If highly speculative investments, like cryptocurrencies, continue to fall and don’t rebound.

Wilson recommends investors emphasize international over domestic equities and upgrade their bond portfolios, avoiding high yield. He advocates for balancing growth and value stocks and suggests adding stocks in defensive sectors, such as utilities.

“There is still plenty of opportunity,” says Wilson. “We’re not at the end of the cycle, but it is time to be vigilant and more tactical.