How Markets Could Respond to the Fed’s Hawkish Stance
What could move equity markets
Equity markets (VTI) trended lower after the US Federal Reserve March meeting minutes were reported. According to the minutes, some US FOMC (Federal Open Market Committee) members were concerned about the rise in equities, allying fears about the possibility of a bubble. There were many other factors that have been in play since then—particularly, US President Trump’s and Chinese (FXI) Premier Xi’s meeting, as well as the geopolitical tension surrounding the chemical attack in Syria and Trump’s subsequent bombing.
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Equity markets, on the whole, might not be an immediate causality, but the prospect of rising yields—once excess Treasuries are offloaded—will likely have a bearing on financial institutions (KRE) and corporations, which, in turn, will affect only some equity markets.
How bond markets could react
After the Fed March meeting minutes indicated a lengthy discussion about trimming the Fed’s balance sheet, bond yields shot up, but the climb proved to be a knee-jerk reaction. Bond prices (LQD) will likely drop again, given the excess supply if the Fed starts selling the bonds in its balance sheet, driving yields higher.
The reason why the chaos in fixed income markets has stalled is likely because there doesn’t look to be a possibility of the above happening soon—not by the end of 2017, at least. But when it eventually does happen, the Fed will likely prepare markets beforehand.
The FOMC March meeting minutes project the Fed’s hawkish stance and continue to signal that the Fed is likely to remain on course for raising short-term interest rates, depending on the economic performance in the US going forward. But there may not be a reason to worry about a bond market (MINT) sell-off anytime soon, given the Fed’s current balance sheet rebalancing plans, as the process is likely to be slow and predictable in 2017.
Meanwhile, the focus is now on federal spending and tax cuts, and the Fed’s decisions are likely to remain cautious, taking care to avoid any unwarranted volatility.