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Interest Rates

US interest rates are set by the US Federal Reserve and specifically the Federal Open Market Committee (FOMC) chaired by Head of the Federal Reserve, Janet Yellon. The FOMC schedules eight meetings a year, about one meeting every six weeks.

Whether the FOMC raises US interest rates, or not, is a key decision which the markets around the world eagerly await. Given that interest rates do not change frequently, it is the press conference after the meeting, and the meeting minutes, which are scrutinised for clues as to the future direction of US monetary policy and the timing of interest rates moves with many global financial markets influencing by the pricing of US interest rates.The US is the largest economy in the world so what happens to US interest rates is important for the global economy and therefore global financial markets.

The FOMC issues a policy statement following each regular meeting that summarizes the Committee’s economic outlook and the policy decision at that meeting. Four times per year the Chairman holds a press briefing after the FOMC meeting to present the FOMC’s current economic projections and to provide additional context for the FOMC’s policy decisions. A full set of minutes for each FOMC meeting is published three weeks after the conclusion of each regular meeting.

Last week saw the publication of the minutes from the last FOMC meeting, clearly stating several members favour a rate hike in June, assuming that the slightly improving US economic data continues and that ‘international events’ don’t undermine confidence. One of those events is the UK ‘Brexit’ vote (see below).

The minutes were a bit of a surprise for the markets, or more ‘hawkish’ than expected, as the markets had not been anticipating a US rate rise so early (the rise is likely to be 0.25% increase in the ‘ Fed Funds’ rate’ from the current 0.50%)

On the back of this relative FOMC surprise:

Fixed Income: US Treasuries and other bond markets sold-off i.e. prices down/yields higher anticipating a higher interest rate/yield environment.

Foreign Exchange: US Dollar strengthened as investors would expect on a higher interest rate outlook.

Equities: Equities relatively unchanged as investors tried to interpret whether higher rates was good news or bad news.

Higher rates can be bad news for economic growth, and therefore company profits, but, on the other hand, the ‘Fed’ would only raise rates if economic growth was relatively good.  

Commodities: Prices fell as the US Dollar rose. Commodity prices have an inverse relationship with the US Dollar i.e. if the dollar strengthens, commodity prices fall and vice versa. This ensures commodities maintains an intrinsic value independent of foreign currency movements.

It is worth remembering that commodity prices have rallied strongly from the first quarter lows with some commodity shares up 100%. Oil is holding on to recent strong gains (due to supply disruption problems and an improving outlook for demand) with Brent crude, the international benchmark, trading at close to $50 per barrel.

UK ‘Brexit’: This issue is very topical for financial markets right now. It is easy to think of Britain’s membership of the EU as a UK specific issue but that is not the case for global investors.

There is some international concern that if Britain did leave the EU then could be the start of a greater unravelling of the EU and European integration project. At a G7 meeting at the weekend, there was a joint statement release from ministers that said ‘the shock of a potential exit from the EU would complicate the global economic environment’. The markets believe a vote to stay is the most likely outcome but June 23rd ‘vote day’ remains a key event.

Equities

S&P 500: 2050

Nasdaq: 4750

FTSE 100: 6100

Bonds – 10 Year Government Yields

US 1.83%

EU 0.16%

GB 1.45%

Foreign Exchange 

EUR/USD  1.1200 (1 euro buys 1.1200 dollars)

GBP/USD  1.4400 (1 pound buys 1.4400 dollars)

Commodities

OIL: Brent: 45.00 (dollars per barrel)

GOLD: 1265 (dollars per ounce)

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Paul McCormick