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Fed keeps favourite phrase of markets

US stocks surge as traders interpret the central bank's latest policy statement as a postponement of interest rate hikes
Friday, December 19, 2014 - 05:50
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Ms Yellen warned that the Fed could raise rates at any time after its March 2015 meeting.

JANET Yellen sounded a lot like Santa Claus to traders on Wednesday as the Federal Reserve echoed its promise to hold off on rate hikes for a "considerable time", sparking the biggest rally of the year on the US stock market. European stocks rose on Thursday, tracking the rally on Wall Street and Asian markets similarly went up.

In the statement, the Fed's Yellen said it could afford to take a patient approach to "normalizing policy", a subtle hint that the central bank was leaning towards rate hikes but was in no hurry to do so. But the officials also emphasised that they were not backing off the pledge to keep rates low for a "considerable time" - throwing a bone to bullish traders who have become fixated on that phrase and nervous about its removal.

"The commentary caught the market by surprise," said Sean Simko, head of fixed-income management for SEI Investments in Oaks, Pennsylvania. "It was more dovish than expected. I think the expectation was there for the committee to take out 'considerable time' verbiage. By leaving in considerable time, they are buying more time. (They now have) another meeting to take that out."

Still, the fact that the Fed broached the question of hikes with the comment about "normalizing" policy was significant, Mr Simko said.

"It's a baby step in going down the (rate-hike) path," said Simko.

Dallas Federal Reserve president Richard Fisher was one of three dissenters to the decision, the others being Philadelphia's Charles Plosser and Naranya Kocherlakota of Minneapolis. Mr Fisher's reason for dissenting was a sense that the Fed might need to move sooner than it currently planned. Speaking after an address at the Dallas central bank office earlier in December, Mr Fisher told journalists that he thought the "considerable time" phrase had been rendered meaningless.

Mr Fisher said the phrase had been "neutered" by assurances, which reappeared in the latest statement, that the Fed's rate plan would be guided by economic and inflation data. At the time, Mr Fisher said it would be "logical" to drop the wording altogether to indicate that the Fed would be willing to move quickly if data warranted.

On Wednesday, Ms Yellen said the Fed's rate-setting committee determined that the impact of the crisis in Russia is likely to be "small" on the US economy. But the oil-price crash, which was the immediate impetus for the near collapse of the ruble, may well have prompted the committee's decision to keep the reassuring phrase "considerable time".

The Russian currency was not the only financial instrument damaged by oil's fall; high-yield bond, a major holding for most Wall Street banks, have also been thrown into disarray amid fears that over-extended oil drillers will default on their debt en masse. Such an event would drive up rates for other distressed borrowers.

The fall in oil prices has also effectively killed inflation in the US, removing the urgency for a Fed policy change. The drop in consumer-price inflation in November was the most pronounced since the financial crisis, according to Labour Department data released prior to the Fed's statement. The situation in the oil markets has even caused some to doubt the market consensus that the Fed will raise rates some time in the middle of next year.

"I don't expect the Fed to raise rates in 2015," said Oliver Pursche, president of money manager Gary Goldberg Financial Services. Mr Pursche said fallout from the oil bust would "do just enough in terms of the capital expenditure and employment picture" to hamstring the US economy.

The Fed targets inflation of around 2 per cent, and with consumer prices - excluding food and energy - rising at a rate of 1.7 per cent on an annual basis, the central bank would "be going against that mandate if they raised rates", Mr Pursche said.

US stocks continued their momentum into Thursday's early trade after Wednesday's sterling performance when the Dow Jones industrial average ended up 288 points, or 1.69 per cent, to 17,356.87, while the S&P 500 gained 40.15 points, or 2.04 per cent - its biggest daily percentage rise since October 2013 - to 2,012.89. The Nasdaq Composite added 96.48 points, or 2.12 per cent, to 4,644.31.

The US market was led by energy companies, miners and steel makers. The bounce in oil prices and beaten-down energy stocks such as Halliburton started before the Fed statement; after all, prices were down five sessions in a row and are overdue a bounce after losing half their value since the July peak.

But traders may also have bought oil futures for the same reason they bought steel stocks: in the hope that the Fed's extension of its loose monetary policy would stir up inflation. Steel and oil are among the first places for inflation - or deflation - to show up. In recent months, the retreat of Europe into yet another recession and China's surprisingly sharp growth slowdown have created a deflationary environment in the global economy and traders of oil and steel have paid the price. Rate tightening in the US would only put more downward pressure on prices.

Shares in Europe rose on Thursday as London's FTSE 100 index jumped 0.94 per cent to stand at 6,396.09 points around midday. Frankfurt's DAX 30 soared 1.86 per cent to 9,722.12 points and in Paris, the CAC 40 rallied 2.27 per cent to 4,205.41.

In Asia, Tokyo stocks jumped 2.32 per cent with the Nikkei 225 index up 390.32 points at 17,210.05. Australia's S&P/ASX 200 Index gained one per cent while The Straits Times Index gained 16.42 points to 3,243.65 and Hong Kong's benchmark Hang Seng Index added 246.37 points to 22,832.21, breaking a five-day losing streak.

Earlier at a press conference after the statement, Ms Yellen warned that the Fed could raise rates at any time after its March 2015 meeting. But stock traders have heard such rhetoric for a "considerable time". After a brief dip, stocks neared session highs. The market interpreted the central bank's latest policy statement as a postponement of hikes.

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