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While the FOMC meeting will presumably have concluded with no change in policy, economists continue to expect US interest rates to be raised more than the markets anticipate in 2016 and beyond. Nonetheless, this prospect should not be as alarming as it sounds, both because it depends on global economic and market conditions improving, and because policy elsewhere is still likely to be loosened further.
"For a start, even we only expect the Fed funds rate to be increased to no more than 2% in 2016, which would still be very low by past standards. What's more, this forecast depends on the US economy remaining strong enough for wage and price pressures to pick up, and on there not being any major adverse reaction in the markets. If these conditions are not met, the Fed would surely go back on hold or even reverse course. Finally, we continue to expect many other major central banks, including the ECB, Bank of Japan and People's Bank of China, to ease further", says Capital Economics in a research note.
Of course, there will be some important implications for the markets. Treasury yields should rebound and the US dollar is likely to strengthen further against other major currencies. Indeed, it would not take much of a shift in rate differentials to drag the euro down to parity, or lower. It is also hard to be very positive on the outlook for US equities. However, euro-zone and Japanese stocks should benefit from local currency weakness and additional QE.
"We are also relatively relaxed about the impact of Fed tightening on emerging market (EM) equities and on commodity prices. Indeed, both might actually benefit from the ending of uncertainty about when the Fed will start to raise rates especially if the first hike were seen as a vote of confidence in the global economy, just as they rallied in the months after the Fed finally began to scale back its asset purchases under QE in late 2013. In any event, the prospects for most EMs depend far more on developments in China than on whether US rates end next year at zero, or a still-low 2%",added Capital Economics.
