The US central bank is widely expected to lift interest rates from record lows this week, marking the Federal Reserve’s first move upward since rates were slashed in response to the 2008 financial crisis.
Yet while the economy is strong overall, investors will be keeping a nervous eye on bond markets after junk bonds – bonds which pay a high return but have a low credit rating – dropped sharply last week, resulting in the liquidation of a mutual fund.
A survey published yesterday by Consensus Economics showed 87 per cent of 250 prominent forecasters believed US rates would go up by 0.25 percentage points on Wednesday. Meanwhile, labour market data at the beginning of the month showed 211,000 jobs had been added in November, paving the way for lift-off.
Federal Reserve chair Janet Yellen said two weeks ago that rates would go up in December provided there were no surprises in economic data in the meantime. However, a strong market reaction is not expected given the move has been telegraphed. Economists have said that the tone of the press conference and economic forecasts will be more important than the move itself, as they will signal how quickly rates will rise.
Economists at investment bank Morgan Stanley are not expecting the second rate hike to come until June next year. Others think the US will be quick to hike.
“We believe that a bigger-than-expected rebound in inflation next year will force the Fed to abandon its gradualist philosophy, with the fed funds rate rising to nearly two per cent by end-2016,” said economist Paul Ashworth from Capital Economics, a consultancy.
One impact of a rate hike could be further volatility in bond markets.
Junk bond prices plummeted last week, with one analyst at Jefferies describing Friday’s trading as a “bloodbath”. US fund management company Third Avenue liquidated one of its high-yield mutual funds on Thursday after a flood of investors tried to redeem their shares for their initial investments.