The Fed as a “culprit” of the recent rally?

US equities suffered yesterday after results from the Citigroup confirmed that the investment part of the banking business is struggling in the current environment. Still the S&P500 remain close to 1300 pts. and just some 6% off ’11 highs (and nearly 20% above the lows).

For those surprised somewhat by that recent resilience of the US markets we have a clue: money markets and the Fed. It was not a surprise to see the FRA rates move in the fourth quarter of the last year as the US economy surprised to the upside. While most do not see the Fed tightening in a foreseeable future, a strong recovery would still give rise to this risk and money markets rightly priced it in. However in January, even as labor market data turned out to be the strongest in months, the FRA rates (9x12 or 12x15) literally collapsed. There is only one factor that could have contributed to this phenomenon:

At the conclusion of their discussion, participants decided to incorporate information about their projections of appropriate monetary policy into the SEP beginning in January. Specifically, the SEP will include information about participants’ projections of the appropriate level of the target federal funds rate in the fourth quarter of the current year and the next few calendar years, and over the longer run (…) (from Fed’s minutes)

It is clear that the Fed wants to ensure that despite the recovery, interest rates will remain at all-time lows and consequently brought the FRA rates back again. That means the Fed’s meeting next Tuesday is a risk for equities: any “good” news is already priced in so even if the Fed delivers, markets might not be impressed any more.

Greece in the spotlight again

Greece is back into the spotlight not only as the Troika arrived to judge progress in reforms but also because talks on the debt swap (agreed in October) take longer than expected. Sides broke talks last week as banks sought a higher coupon on new bonds after some transition period that would reduce the duration on this new debt. Nevertheless, IIF’s J.Ackerman remains optimistic:

I think we are in a situation where everybody is trying to get the most out of it, but in the end we’ll come to an agreement.

Still it is a risk for the markets as many hoped the Greek issue was off the table. The negotiations will start today again.

Przemysław Kwiecień PhD, Chief Economist

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