There was a sentiment shift in the markets this week. Following a speech from Federal Reserve Chair Janet Yellen in Chicago on Friday, and other Fed governors and speakers leading up to her, it now seems with more certainty there will be an interest rate hike announced at their meeting on March the 15th. Investors are pricing in a near 80 per cent probability that they will do so, (and it can be tracked here). In the short period between January 25th 2017, and the 1st of March, the Dow traded from 20,000 all the way to 21,000. With nothing standing its way, except the old adage that bull markets climb a wall of worry, the first obstacle for the exuberance of these US equity markets has presented itself. Within two weeks, we’ll see what, if any, challenges the Fed decision presents.
The US Federal Reserve cannot risk being behind the curve when it comes to raising interest rates. The rationale for this is simple. If they don’t raise rates when they are able, it’s unknown what extraneous event will prevent them from doing so in the future in this risk prone world. And in fact, some of the harsher critics of the US Fed in years past have been the ones that take issue with when they failed to raise interest rates. One example was not raising rates in September 2015, when heightened market and economic uncertainty throughout the remainder of that year nearly kept them on the sidelines despite an improving US economy.
Outside of the domestic US economy, last year’s focus seemed to be as much on international events such as Brexit. To date, the impact of Brexit on the North American economy has been minimal; moreover, it did hinder the Fed from raising rates last summer and unsettling what were already vulnerable markets. In hindsight, the sentiment around the lead up to Brexit fits even more with ‘the wall of worry’ scenario impacting the equity markets. However, what other reaction would one expect from herd mentality, or even rational investors, who are experiencing an unknown event for the first time that deviates from what might be considered the status quo.
It is simply for the reason of being able to raise rates that we could see the Fed act as soon as March, and investors can and will take that as the much criticized and analyzed institution not wanting to fall behind the curve. For the markets, this may be a positive. While many had questioned their ability to “remove the punchbowl” from the party, meaning eventually raising rates, these minor rate hikes have been so gradual they do not yet look to stand in the way of the advancing equity markets.