The US Federal Reserve had yet to announce its rate decision when I wrote this article. But I believe the latest Fed statement would not bring any surprises to the market, including the economic outlook and timeframe to change the balance sheet. In fact, the US dollar and 10-year US Treasury yield have already been priced in.
The US dollar has been weakening and the 10-year Treasury yield has been falling since the second rate hike last month. Fed chair Janet Yellen has offered some clues to the rate policy direction in her latest speech. The market has gotten rid of the strong fear for further rate hikes or balance sheet changes.
Former Fed chairman Ben Bernanke has suggested two criteria to determine the schedule and pace of tapering. First, the unemployment rate should fall below 6.5 percent, and inflation should edge above 2.5 percent.
The US unemployment rate has improved to 4.4 percent, while core inflation has sustained below 2 percent for quite some time. Yellen has said that because of the measures the Fed has taken, another financial crisis is unlikely “in our lifetime”. It indicated that the Fed has very limited room to hike interest rates amid the low inflation environment.
As a result, the three US stock indices have kept hitting new highs, and the market sentiment has not shown any sign of reversal We have not read any bubble burst from either analyst reports or newspaper articles.
Instead, the earnings of leading US corporates have beaten our expectations. It’s reported that 80 percent of S&P 500 constituents have posted better than expected earnings. I believe a market correction might occur, but it won’t alter the upward trajectory.
Meanwhile, the bond market remains steady, with massive capital inflow into debt funds. The 10-year US Treasury yield has eased to 2.3 percent from nearly 2.4 percent, and the yield curve is flatter. That reflected expectations for less pressure on rate hikes and low inflation.
Under such a scenario, asset prices have a much better chance to move upward than head south. Apart from economic factors, the choice of Yellen’s successor is also critical.
Yellen’s term expires in February 2018. US President Donald Trump criticized her during his election campaign, but he seemed to take back his words by saying he might nominate Yellen to serve a second term.
Trump also said that Gary Cohn, a former Goldman Sachs banker, is another frontrunner for the job. Cohn has worked for the US investment bank for 26 years. Let’s wait and see who will be the next Fed chief.
This article appeared in the Hong Kong Economic Journal on July 27
Translation by Julie Zhu
[Chinese version 中文版]
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