Originally this week’s write-up intended to focus on the current situation in Venezuela, whereby the political saga escalated to very concerning levels with the President declaring a state of emergency.

However, despite being aware that Wednesday the Federal Reserve (Fed) was publishing its monthly minutes for the month of April, we surely did not expect the change in tone in regard the possibility of an imminent uptick in rates. No worries, we will surely discuss Venezuela shortly, also in line with the unfolding deteriorating situation, which is also affecting the country’s financial market.

Undoubtedly the market wasn’t expecting the tightening language, in terms of monetary policy. In fact, this was being reflected in the low probability of a rate hike the market was pricing before the published minutes. The minutes showed that despite members kept on stressing out the point that further improvement in data is necessary, most members agreed that a rate hike in June would be appropriate if positive data is sustained over the remaining period. Thus so far nothing out of the ordinary.

In my view, the trigger point this time round was the fact that the month of June was mentioned as possible timing for hike, in addition to the omission of the highly stressed point, which was noted in other statements by the Fed, in which it had warned that global developments continued to pose risks. It is of no surprise therefore that a hike is an almost certainty in 2016, it is more a question of timing.

Good news is bad news - market reaction

Markets were shocked by the wave of consensus by the FOMC members which tabled the possibility of a rate hike imminently. In fact, following the announcement stocks sold-off sharply, the dollar spiked, mainly against emerging market currencies, which in turn also posed downward pressure in dollar denominated emerging market debt.

The sell-off continued yesterday across the board, following the re-assurance by Dudley, New York’s Fed President, who stated that June is definitely a live meeting for a rate hike. The S&P hovered lower at around the 0.6 per cent levels, while 10-yr Treasuries dipped to the 1.844 per cent levels, as the risk-off mode was triggered.

Reality

However, despite the hawkish tone being negatively digested by market participants, let’s be realistic. The U.S. economy is healing, looking at this week’s latest indicators, housing starts remained robust, while industrial production and consumer inflation exceeded expectations, according to last Tuesday’s figures. In addition, the number of Americans filing for unemployment aid fell from a 14-month high last week, another sign of a seemingly sustainable economic recovery.

Thus theoretically, from an economic perspective, a tightening policy (rate hikes) signals that the economy is improving, following satisfactory inflation figures and a strong labor market. This would also imply that demand would increase as people would have more disposal income and thus increase their spending, which in turn should boost revenues for companies. The ripple effect will lead to companies registering higher profits which will in turn maximize shareholders wealth. Following this economic thought, equity markets should react positively, however such reaction till yesterday seemed to be farfetched.

My take is that investors still fear that a rate hike at this stage is detrimental towards economic recovery, even in view of the current global slowdown. Thus markets are expressing a strong sentiment of fear that the recovery gained so far might be blurred. That said it is surely an unhealthy situation primarily for the financial sector if rates are maintained at very low levels. Certainty at this point the market is shouting for a ‘no rate hike’.

This article was issued by Jordan Portelli, Investment Manager at Calamatta Cuschieri. For more information visit, www.cc.com.mt .The information, views and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice. Calamatta Cuschieri Investment Services Ltd has not verified and consequently neither warrants the accuracy nor the veracity of any information, views or opinions appearing on this website.

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