Rate rise anxiety returns, amidst stronger economic data

20 May 2016

It worried capital markets for most of last year and was the starting point to the Jan-Feb 2016 stock market tantrum: Concerns that the US central bank, the Federal Reserve (Fed), would raise interest rates for the first time in a decade, before the economy in the US and globally was ready for it.

They finally raised rates late December 2015 and markets plunged from the beginning of January on the first sign of economic weakness in the US. In the end markets accepted that the US economy is not imminently descending into a recession (quite the opposite judging by this week's strong retail sales numbers) and the Fed signalled that they would wait a bit longer with the next rate rise. Stock markets bounced back, the oil price recovered and markets somehow came to believe that the next rate rise would now only be in December again - not the 4 upwards moves for 2016 the Fed had indicated in Dec 2015.

Well, over the past week rate rise anxiety returned as the publication of the latest meeting minutes of the Fed's rate setting committee revealed that markets had over interpreted the Fed's hesitation in March and that a rate rise before the summer recess is well on the cards as far as the Fed is concerned.  Predictably markets disliked this change of expectations and sold off - but only 1-2%. By Friday market close the fall had been recovered and so the jury is out for the moment whether the markets have become a little more resilient since the hurdle of the first rate rise was taken last year and the ensuing market correction proved unjustified.

It seems that the flow of macro-economic data that currently points to a strengthening of consumer demand and stabilisation of oil and commodity related industrial activity was powerful enough to persuade the '˜fast money' that perhaps the Fed is right to push ahead with the next rate rise. Unfortunately, I am not convinced the '˜peace' will hold. Two of the three reasons why markets recovered - a weakening US$ and a strengthening oil price - look decidedly exposed to instability.

Oil has been touching on $50/bbl, up more than 80% since its January lows without a discernible change to the supply glut constellation which sent the price reeling in the first place. The US$ has recently regained some of its so beneficial weakness and is up a good 4% since its lows a few weeks ago.

The prospect of a rate rise before the UK's EU referendum and the US presidential election in the autumn together with the implications of oil and the US$ will therefore add additional anxiety potential to a market environment which is already suffering from Armageddon Paranoia.

At Tatton, we will therefore continue to watch the data flow and market action very closely. Only once we gain confidence that the market is accepting that the second half of 2016 will bring distinct economic growth acceleration will we consider deviating from our current watch and wait position, which has served our investors well in manoeuvring their investment portfolios through the currently so choppy sea of global investment markets.