Fed's cautious tone a reprieve for rate-sensitive sectors, commodities

US STOCKS rose, Treasury yields fell and the dollar plunged after the Federal Reserve's cautious tone assuaged fears that the central bank was becoming more aggressive with its interest rate plans.

As at 11.52am EDT on Thursday, the Dow was at 20,909.36, down 40.74 points.

The central bank raised its benchmark interest rate by a quarter of a percentage point to a range of 0.75 per cent to one per cent, in what was one of the most clearly telegraphed plot twists since the last episode of Friends. Futures markets had priced in a near 100 per cent chance of a hike. The surprise was that the central bank left its "dot plot" - board members' predictions of coming hikes - unchanged. The board anticipates two more hikes this year.

"On balance, the signal from the meeting was more cautious than expected," said analysts at brokerage Bank of America Merrill Lynch Global Research, in a note to clients. "In the press conference, (Fed) chairwoman Janet Yellen gave balanced comments and reiterated that the Fed has not significantly changed its assessment of the economy or the path of the hiking cycle since the last meeting."

Last week, rate-sensitive stocks such as utilities had fallen sharply and the yield on the 10-year Treasury note hit its highest level in more than two years because of a sense that the Fed was moving up a gear in its rate cycle. Statements from Fed officials had indicated that - after years of rolling crises - things had finally returned to normal in the Fed's eyes, at least for the US economy. "Normality" is, of course, a matter of perception, but for the Fed, it would mean raising rates from their current level closer to the historical average of 5 per cent.

This was the second hike since December and the third since the Fed started withdrawing stimulus measures in late 2015. Some voting members on the Fed board, including Dallas Fed president Robert Kaplan, warn that the central bank could see unintended consequences of maintaining record-low borrowing rates for too long. These could include another market distortion such as the housing bubble that blew up in 2009. Some observers say house prices and mortgage lending in the US went out of control when former Fed chairman Alan Greenspan cut rates aggressively in the wake of the Sept 11, 2001, terrorist attacks. For now, however, the board seems to agree that the dangers of going too fast on hikes - such as choking off economic growth - are greater than the dangers of going too slowly.

It's possible that the Fed will hike more than current targets for the year if recent trends in the data hold. For the first time since the financial crisis, both of the central bank's mandated spheres of control - inflation and economic growth - are flashing "hike" signals.

Recent inflation data has indicated that, after a long lull, consumer and producer prices are feeling upward pressure. Consumer price inflation is already around the Fed's 2 per cent target, above which it would use rate increases to rein in prices.

"In a relatively short period of time, the US inflation picture has escalated from dormant to a state of semi-perkiness," said analysts at brokerage Jefferies in a note to clients, predicting an elevated 3.2 per cent inflation rate for the third quarter. "Higher inflation has not been a good thing in the past for equity markets, as performance generally weakens as inflation rises. A faster pace of rising inflation could bring about more rate hikes, which also weakens returns."

There's also some gentle pressure coming from the growth side of the equation: the American labour market is seeing the fewest layoffs since the early 1970s, a sign of an economy ramped up to near maximum capacity.

One reason the central bank is moving so cautiously could be the slow start to economic policy from the new presidential administration.

In her press conference, Ms Yellen said the central bank would have to wait and see what the fiscal and tax policies are before making any necessary amendments to monetary policy.

Relations between the Fed and the US president are more delicate than usual, said John Canally, chief economist at brokerage LPL Financial. Many Donald Trump supporters resent the economic powers of the central bank, though Treasury Secretary Steven Mnuchin has indicated he is content with the status quo.

For commodities prices and rate-sensitive sectors of the stock market, Ms Yellen's cautious tone was a reprieve.

The price of a barrel of oil was down about 10 per cent from its February peak before rebounding on Wednesday - mostly due to concerns about production levels from Opec and the US, but also likely because of dollar fears. In 2015, anticipation of Fed rate hikes drove up the dollar against the euro and emerging-market currencies, hastening a crash in the prices of US dollar-denominated raw materials from oil to copper and grain. The dollar's strength also slowed corporate profit growth and was one of the major reasons that the Fed left rates unchanged for much of 2016.

The dollar fell more than one per cent against a basket of currencies in the wake of the Fed's statement.

As they consider the pace of hikes to come, central bankers will have to consider the dangers to global growth posed by sudden moves in the mighty greenback.

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