The Price of Money: FED ‘Aggressive’, Wall Street Cautious

On Wall Street, the S&P 500 and Dow Jones indices reached new record levels on Wednesday, while the Nasdaq index weakened in cautious trading after the Fed announced a reduction in its balance sheet and signaled the possibility of interest rate hikes in December.

The Dow Jones strengthened by 0.19 percent, to 22,412 points, and the S&P 500 by 0.06 percent, to 2,508 points. The Nasdaq index, on the other hand, weakened by 0.08 percent, to 6,456 points.

After a two-day meeting, leaders of the U.S. central bank left key interest rates unchanged, as expected. However, the Fed signaled that another, third increase in the price of money this year is possible in December, despite weak inflation.

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Since the beginning of the year, the Fed has raised key interest rates twice by 0.25 percentage points each time, and the market estimated that due to low inflation, the Fed would likely not raise the price of money again this year.

However, now traders in the money market estimate that there is about a 67 percent chance that the Fed will raise rates in December, while before the Fed’s messages, those chances were around 50 percent.

Additionally, the Fed announced the start of reducing its massive balance sheet of $4.2 trillion from October, during which it will monthly reduce its portfolio of government bonds and other securities by $10 billion.

Autopilot

While some analysts believe that the Fed is more aggressive than expected, others are satisfied because the central bank’s chair Janet Yellen reiterated that the balance sheet reduction and other Fed decisions will depend on economic indicators.

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“The most important thing Yellen needed to communicate is that plans for balance sheet reduction and interest rate hikes are not on autopilot, which she did,” explains Jason Pride, a director at Glenmede.

As interest rates are expected to start rising, yields on government bonds increased yesterday, benefiting stocks in the financial sector.

Thus, this sector was the biggest winner yesterday, with prices rising by an average of 0.6 percent as higher rates would increase bank profitability. This sector has risen in eight of the last nine days, strengthening more than 6.5 percent during that period.

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On the other hand, stock prices fell yesterday in sectors considered defensive, which could be harmed by higher rates. Prices in the consumer sector fell by 0.9, and in utilities by 0.8 percent.

European markets also traded cautiously yesterday. The London FTSE index weakened by 0.05 percent, to 7,271 points, while the Frankfurt DAX rose by 0.06 percent, to 12,569 points, and the Paris CAC by 0.08 percent, to 5,241 points.