Fed statement frightens the horses

Although last week’s quarter-point rise was expected, the hawkishness of the accompanying Fed statement was not. It retained its commitment to a “measured” stance on interest rates, but other references were taken to mean that the rise in interest rates could last for longer than previously expected. The Fed has increased the federal funds rate seven times from its low point of 1% from mid-2003/4 to 2.75% now (see graph).

The misery was compounded when the American Bureau of Labor Statistics published worse-than-expected inflation figures. The consumer price index increased by 0.4% in February after a 0.1% rise in January – although last month’s rise was accounted for by rising energy prices. Peter Hensman, global strategist at Newton, says: “The upside surprise in the inflation release became that much more important after the Fed statement.”

Both bonds and shares suffered as a result of the two sets of bad news, although some sections of the fixed interest market fared worse than others. Short-dated debt was generally hit harder than long-dated debt. Emerging market bonds and high-yield corporate bonds also suffered more than most.

American and European equities also fell, although it is not clear whether the changing interest-rate environment will have a long-term effect. “If the Fed tightens more quickly than expected, it could lead to a re-evaluation of growth expectations,” says Hensman.

In contrast, the dollar was bolstered by expectations of a more sustained rise in interest rates. US rates are expected to be higher than eurozone or Japanese rates by a wider margin than previously assumed.