Fed move to lift US stocks and dollar

ALTHOUGH the Federal Reserve was keen to downplay its surprise move last Thursday, the markets initially reacted strongly to its announcement that it would hike the rate it charges banks for emergency loans.

But while the currency market saw the biggest moves – the dollar strengthened to a nine-month high of $1.5345 against the pound on Friday and made healthy gains against the euro – global equities remained relatively unfazed by the surprise decision. Asian markets were slightly weaker but European markets shrugged off the decision on Friday and the FTSE 100 closed up at 5,358 – its highest level in almost a month.

They interpreted the decision as a step towards normalising monetary policy. So if further tightening is on the cards, what will be the impact on currencies and global equities of further tightening, and how should spread betters react?

Angus Campbell, head of sales at spread betting-provider Capital Spreads, says that the Fed’s move was a shot across the bows to let investors know that the era of cheap funding is coming towards an end. “Those who are exposing themselves to risk should have a think about where things will be in six months time,” he says.

While there was not the knee-jerk reaction that some might have expected (and the Fed feared), investors did lose some of their appetite for risk. Kenneth Broux, strategist at Lloyds Banking Group, says that the market reaction speaks for itself: risk off while dollar and bond yields up.

While euro-dollar continued to slide, flirting with the $1.35 level, the clearout in sterling-dollar is what caught Broux’s attention. Dreadful UK retail sales data on Friday dragged the pair further below $1.54. “With key technical support in the $1.5535 area out of the way, the pair has a clear run at $1.50,” he says.

Clearly, an expectation of earlier tightening in the US will boost the greenback as it suggests that the Fed is now feeling comfortable enough with both the US and the global economy to tighten rates. Rising rate expectations will widen the yield differential between the US and other G10 countries like Japan, the UK and the Eurozone. Spread betters could look to go long on the dollar or add to positions.

While it might seem perverse, the hike is good news for the US markets, says Charles Schwab’s Kully Samra. “The US stock market is still going to be rising – it’s fairly-valued, inflation is low and the recent correction has taken some of the speculative froth out of the market.”

Spread betters should therefore be piling into long US equity positions. Stocks are cheaper following the correction and because spread betters don’t have any currency exposure, the stronger dollar won’t do any harm either. Traders could also take out long speculative positions on the dollar, which is expected to remain strong in the first half of this year. The Fed’s move will have given the buck some extra shine.