While markets had largely priced in an increase in the federal funds rate this month, fund managers have begun looking ahead to the next move by authorities.
Having raised the target range for the federal funds rate in December, the Federal Open Market Committee – led by Federal Reserve chair Janet Yellen – raised the target range for the federal funds rate from 0.75 per cent to 1 per cent yesterday.
In a statement the committee noted the strengthening of the US labour market and increased economic activity since its previous meeting in February.
It also highlighted increases in inflation during recent quarters edging towards its longer-term 2 per cent target.
Federal funds target rate since start of data
Source: FE Analytics
However, more interesting to fund managers and analysts were Yellen’s comments about future rate movements.
Shilen Shah, bond strategist at Investec Wealth & Investment, says a “neutral bias” in Yellen’s comments had been read “bullishly” by markets.
He said: “The confirmation that the Fed appears to be in no hurry to increase interest rates materially in 2017 or 2018 saw government bond yields fall, with the 10-year US Treasury yield dropping below the psychologically-important level of 2.6 per cent to trade at 2.52 per cent.”
Patrick Schotanus, multi-asset investment strategist at Kames Capital, said the pace of hikes was likely to continue for the next two quarters with further increases of 25 basis points in June and September, unless economic conditions deteriorate.
Schotanus labelled the increase “dovish”, noting that the Yellen was willing to tolerate inflation rising above its 2 per cent target.
Indeed, Andrea Iannelli, investment director at Fidelity International, said the Fed was “in no rush to speed up the pace of tightening and will take it slowly from here”.
Iannelli said the outlook remains bullish for risky assets, including credit, and for US Treasuries. He warned, however, that the US dollar “is likely to lose some steam” with the focus now shifting to other central banks.
He said: “The longer term picture, on the other hand remains heavily dependent on the fiscal stance that the new US administration decides to adopt, although it may be difficult to pass any meaningful stimulus measure before next year.”
Abi Oladimeji, chief investment officer at Thomas Miller Investment, said optimism since the election of Donald Trump as US president had stemmed from some of the potential policy proposals during the campaign.
He said: “Clearly, well-designed policies that cut taxes, boost infrastructure spending and reduce regulatory burden will stimulate growth and spur inflation.
“However, the delivery of these policy proposals entails significant implementation risks. The Fed is right to adopt a ‘wait-and-see’ approach.”
He added: “The pace of US economic growth picked up strongly in the second half of 2016 and key leading economic indicators continue to flag that barring any unforeseen negative shocks, the pace of economic growth should remain above trend during the first half of 2017.
“Viewed in that context, the Fed’s decision to move early in the year can be seen as risk management. While there may be upside risks to inflation, there remain notable downside risks to growth projections.”
Ian Kernohan, economist at Royal London, said it was right that Fed officials remained cautious.
“With the scale, mix and timing of any fiscal stimulus still very unclear, the Fed is right to be cautious with the pace of tightening, despite some robust economic data in recent weeks.
“We expect more rate hikes this year, which should be supportive of the dollar, given other major central banks are unlikely to tighten policy for some time.”
Following the Fed announcement, the Bank of England announced on Thursday that it would be maintaining the base rate of interest at 0.25 per cent, while the Bank of Japan also left monetary policy unchanged.
The announcement did prove a boost for markets, despite a fall in the value of the US dollar.
Performance of S&P 500 & MSCI World over 1mth
Source: FE Analytics
“After a day of strengthening, the dollar also weakened, with the dollar index down 0.9 per cent on the day,” said Investec Wealth & Investment’s Shah. “A cautious Fed was also supportive for equity markets with US and global equity indices pushing higher following the statement.”
"This was only the third rate hike since December 2015, but the move had been fully anticipated by markets following strong signals from the central bank in recent weeks," said Keith Wade, chief economist at Schroders.
"Bond and equity markets have rallied following the announcement as there had been expectations of a more hawkish tone from the Fed, but chair Janet Yellen maintained her reputation as a dove in the post-meeting press conference."