Fed’s call: Twin threats could raise red flags
The Federal Reserve kicks off its two-day policy meeting Tuesday, and futures are pricing in a roughly 80% chance the Fed will hike interest rates for the first time since 2006. But there are two risks:
1) Fed increases rates and hints that a more aggressive rate-hike plan and pace is in the cards.
2) Fed punts and doesn’t hike rates, just as it did in October, when the U.S. central bank cited international turbulence for its no-go decision.
Scenario No. 1 would suggest a less-dovish, or less-market-friendly Fed. Translation: more coming rate hikes than investors are now positioned for. The market is pricing in a quarter-point hike Wednesday and two quarter-point moves in 2016. Short-term rates are currently pegged around 0%. If Wall Street thinks four or more hikes are on the horizon next year, it will change the market’s investment calculus.
“We worry the Fed may not be able to sound dovish enough to placate markets,” Michael Hanson of Bank of America Merrill Lynch said in a report.
Scenario No. 2 could create a situation where investors fear the Fed perhaps knows something the market does not — and that economic risks to the downside are greater than feared. Says Luke Bartholomew at Aberdeen Asset Management: “The Fed will have made a spectacular hash of things if they don’t hike this week.”
As the Fed decision looms, markets are rocky and turbulent just as they were heading into the Fed's October meeting. Last week, U.S. stocks fell nearly 4%, before rebounding 0.5% Monday and pointing 0.7% higher in pre-market trading today. Adding to the angst: a meltdown in the high-yield bond market, where investors are dumping so-called “junk” bonds tied to energy firms, where default fears are rising amid oil’s drop to seven-year lows.