Jitters around risk assets ahead of Fed rate hike

RBA governor Glenn Stevens: Board relaxed on Australian economy, dollar as US counterpart prepares for rates lift-off. Photo: Luis AscuiThe US Federal Reserve is almost certain to start lifting interest rates for the first time in almost a decade this week, in a long-anticipated move that markets already have priced in to assets.

Most analysts, then, expect only mild disruption ahead and after the Fed’s announcement, early on Thursday Australia time, with the Australian dollar, for one, set to rise as the greenback corrects slightly.

However, the increase in the Fed funds rate, from between 0 and 0.25 per cent to between 0.25 and 0.5 per cent, also comes amid ongoing weakness in commodity prices, concerns about the slowdown in China and widening cracks in high-yield corporate and emerging market bonds.

US asset manager Third Avenue shut down its $US789 million high-yield credit fund on Thursday, triggering fresh jitters in the high-risk corporate bond sector, which spilled over into equity markets. High-yield-bond exchange-traded funds JNK and HYG fell to their lowest since 2009 on Friday, while the S&P 500 stock index lost nearly 2 per cent, leaving it down 3.8 per cent for the week.

The late-week upheaval means the Australian stock exchange is set to open on Monday down a hefty 1.45 per cent, according to futures pricing. The shaky start follows a  2.4 per cent decline for the index last week, which has it down 2.65 per cent so far in December.

The performance has left equity market matchers wondering if the hoped-for “Santa” rally is going to materialise this year, with resources, energy and financial stocks all weighing on sentiment since the China-led market turmoil of August.

Online broker Market Matters noted at the weekend that while US equities had recovered since then, Australia’s have languished.

“What remains very unsettling for local investors is that the ASX200 will open on Monday very close to the recent late-September lows, while the Dow [Jones Industrial Average] is still an impressive 12.3 per cent above its panic August low,” it said. Mid-year economic and fiscal outlook

Other drivers of local equity, currency and bond markets this week include Tuesday’s minutes of the Reserve Bank of Australia’s last board meeting, on December 1, and the federal government’s mid-year economic and fiscal outlook (MYEFO), also on Tuesday.

The former is unlikely to hold surprises, after the RBA held the cash rate at 2 per cent for the seventh month in a row, and left the commentary largely unchanged from November. The minutes predate strong third-quarter gross domestic product figures and last week’s extraordinarily good labour market survey for November. MYEFO is likely to confirm modest widening of the budget deficit, mainly because of further deterioration in iron ore prices.

National Australia Bank senior economist David de Garis expects the full minutes of the last RBA meeting to reflect a board which is relatively sanguine about domestic growth and the recent resilience of the Australia dollar, although he does see it fleshing out its view on why commodity prices continues to decline.

On the currency, the RBA would have contained “its anxiety until after some of the effects of Fed rate liftoff and currency markets begin to become apparent”, he said in a note to clients at the weekend.

“It’s likely then that the RBA will hold its fire and not unleash further Australian dollar jawboning.

“Rather, we expect the bank to reflect over the summer on its internal valuations of the Australian dollar in the face of the continued decline in Australia’s terms of trade and the market’s reaction to this coming week’s expected liftoff from the Fed.”

The Aussie was last fetching US71.89¢, after an overseas sell-off late on Friday driven by jitters around emerging markets and commodity exporters ahead of US monetary tightening.

“In general, though, a Fed rate hike on Wednesday would probably not cause panic in financial markets,” said Capital Economics’ assistant economist Andrew Hunter.

“Indeed, as a hike is now almost universally expected, the initial market reaction may, if anything, be positive.

“This may be especially true if, as seems likely, the accompanying statement reassures investors that the subsequent pace of tightening will be gradual.”

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