Are Financial Markets Responding Prematurely about a U.S. Interest Rate Rise?

The markets are already pricing in an interest rate rise by the Federal Reserve in a week’s time, but this could be premature, warns a leading global analyst at one of the world’s largest independent financial advisory organizations.

The warning from Tom Elliott, deVere Group’s international investment strategist, comes ahead of the next Federal Open Market Committee (FOMC) meeting on December 13 and 14.

He comments: “Financial markets are pricing in as a certainty a 25bp rate hike at the forthcoming FOMC meeting. This will take the key Fed funds rate up to a range of 50bp-75bps.

“Supporting the market’s view is the strength of the U.S. economy, with some strong data emerging last week that suggests inflation pressures are building.

“This data includes that third quarter GDP growth has been revised upwards from 2.9 per cent annualised, to 3.2 per cent; a key housing statistic (the Carelogic Cas Schiller National Price Index) passed its previous July 2006 high; November payroll data was strong at 178,000 new jobs created, while the unemployment rate fell to 4.6 per cent; and CPI inflation is at 1.6 per cent, which is in spitting distance of the Fed’s 2 per cent target.”

Mr Elliott continues: “However, the markets’ pricing in of a rate rise at this stage could be premature.  Indeed, we have seen similar market certainty of a rate hike several times before this year, notably in May.

“The prime cause of uncertainty this time is not fear of a rash of weak economic data, but how the dollar behaves over the coming week.

“If it continues to strengthen, in anticipation of higher Fed rates, the Fed may actually hold off. A strong dollar exerts its own form of monetary tightening because exports weaken, import prices fall and so put a downward pressure on domestic competitor prices.

“The Fed may prefer to delay a rate hike, than impose a double-dose of higher borrowing costs on corporate America as well as a still- stronger dollar.”

Mr Elliott concludes: “The Fed has been signalling for some time that it will raise interest rates in the world’s largest economy before Christmas and, as such, the financial markets have reacted accordingly. 

“However, markets can and do get it wrong sometimes and therefore investors need to remain vigilant and not be complacent.  Whatever the Fed decides to do in a week’s time will very much now depend on the dollar. 

“Either way, there will be rewarding opportunities for those investors who have a good fund manager and who are appropriately diversified.”