Hooray finally a rate hike!

Hooray finally a rate hike!

Today the Fed raised rates by 0.25% and set the market a twitter. Yellen forecast 3 rate hikes next year amid an economy that as forecast would grow to about 2-2.1% and inflation remaining broadly in line with expectations. Wow! Basically the Fed is saying that with the economy at close to full employment and with all the supposed fiscal stimulus the economy would not grow significantly more. Personally I find this a little hard to digest because no one knows what stimulus is going to occur and if one recalls under a weaker scenario some months ago Fischer suggested 4 rate hikes in 2017.

Corporate America is now in for a change. We will need to see increases in productivity rather than cost cutting or taking the margin that lower interest rates provide. Either way interest rates are on a projected rise, inflation is to rise slightly although it could rise significantly more and what should have been a bear move on the yield curve has turned into an adjustment of bonds across the curve.  The 2 year has risen about 10 bp and this is unusual. The two year is currently around 1.26%. The 10year Treasury also moved some 10 bp to trade around 2.55%.  The dollar was stronger oil was weaker, equities were weaker and gold was lower.

Fiscal stimulus is of concern, as we already have the US economy at close to pareto, all be it. The fiscal stimulus may end up being a lot lower however the tax cuts could be quite large, and this could cause the Fed to move more aggressively meaning more rate hikes or larger rate hikes. Forecasting will become very important over the coming months. The risks of central forecasts is on the upside, i.e. more growth, more employment higher inflation etc meaning that rate hikes will be faster and larger. What this all means is that perhaps the Fed is already a little behind the curve and any accelerant will need to be doused with sharper rate rises as the economy in isolation is reasonably sound. The drag for the USA are the emerging markets and Europe, should either become resurgent then expect rises more frequently and larger than current forecasts suggest.

Aussie Market Today.

Bonds were weaker, equities were weaker commodities were weaker, it is hard to see how anything other than a weak market can exist in the Aussie Market today. What I do find fascinating is that UST 10 year vs Aussie 10 years are now spread at around 30 bp. The long term average is closer to 100. I cannot see how this relationship at 30bp can exist or persist for any period. In the new normal this relationship is around 40-50bp so either way Aussie Bonds are now massively expensive. The UST 30 year is about 3.15%. Overall bonds have now moved around 80bp and appear to have a way to go for a while yet. Credit was a little weaker overnight.

For the Australian Banks this movement in bond yields will mean higher borrowing costs and that means mortgage rates are set to rise irrespective of what the RBA does. The Aussie Banks main funding sources is in Europe and the USA and they have MTN programmes that seek to raise many billions to fund their mortgage book.