US stocks jump while bonds drop as markets calmed by rate path

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So far, so good. That’s what Federal Reserve Chair Janet Yellen must be thinking after watching the reaction in markets to the U.S. central bank’s first interest-rate increase in more than a decade.  

Rather than marking a turning point for investors, the mood was one of relative calm. Stocks built on gains from earlier in the session, the dollar advanced versus half of its major peers, and even emerging-market assets climbed with junk bonds. While Treasuries fell, yields on the benchmark 10-year note failed to rise above levels seen earlier this month, suggesting borrowing costs will be contained. Indications future rate hikes will come at a gradual pace supported gold as expectations for equity volatility slid.

Financial markets, reacting to the first rate increase since before the 2008 recession, reflected growing conviction among investors that the U.S. economy is strong enough to withstand higher borrowing costs, even as the threat of inflation increases. Gains built in equities over the afternoon as Yellen stressed the Fed’s gradual approach, noted signs growth is strengthening in developing markets and repeatedly dismissed concerns about inflation, saying wages showed evidence of strength.

“Everything seems to be as expected and all the markets seem to be hanging in there,” Mark Kepner, an equity trader at Chatham, New Jersey-based Themis Trading LLC, said by phone. “The decision was unanimous, which was a big deal because you want to see a conviction here among everyone on the committee. And as far as where they expect rates to be at the end of next year, it’s also the same as expected.”

The Fed raised interest rates for the first time in almost a decade in a widely telegraphed move while signaling that the pace of subsequent increases will be “gradual” and in line with previous projections. The move ends an era of unprecedented monetary stimulus that pushed stocks higher by more than 200 percent and added $15 trillion in value during the 6 1/2-year bull market. Investors will now find out what stocks and the dollar are worth without the central bank stoking economic growth as aggressively.

“We finally got some clarity from the Fed, something we haven’t had for a while now, and that’s always a positive,” said Matt Maley, an equity strategist at Miller Tabak & Co LLC in New York. “We also know they’re going to be dovish, and while people figured that would be the case, it’s still good to get confirmation.”

Stocks

The Standard & Poor’s 500 Index pushed its gain past 1 percent as Chair Janet Yellen indicated that the economy could overshoot if the Fed hadn’t raised its target rate by 25 basis points.

The U.S. benchmark closed up 1.5 percent at 2,072.97 by 4 p.m. in New York. The rally was led by General Electric Co., which reached the highest in seven years after projecting the return of about $26 billion in cash to investors through dividends and buybacks.

The Chicago Board Options Volatility Index sank 15 percent to 17.77, the biggest drop since Dec. 8. Volatility surged last week as stocks had their worst period since August.

“It’s the Fed giving its seal of approval on the economy and financial conditions, but also the Fed didn’t surprise with more aggressive future path,’’ Stephen Wood, who helps manage $237 billion as chief market strategist for North America at Russell Investments in New York, said by phone. “This is a very dovish rate increase. It came right in in line with expectations.”

When it comes to equities, history suggests two immediate consequences from tightening: higher volatility and lower valuations, meaning earnings and ultimately the economy are left to drive prices. The Fed is tightening at a time when profits are in decline, a combination that hasn’t occurred in five decades. 

Investors have spent the second half of 2015 coping with the first correction in four years and an increase in volatility that by some measures was a record. From plunging oil to emerging market turmoils and the selloff in junk bonds, anticipation of the Fed’s retreat added to anxiety that’s already pushed the VIX above levels at the start of past Fed liftoffs.

(Bloomberg)

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