Central Banks

Global markets unconvinced by Fed inaction

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If the Federal Reserve hoped its decision to keep interest rates steady on Thursday would soothe frayed nerves at home and overseas, it's likely to be disappointed.

While a delay in a rate rise on paper should help support risk assets, markets were left wanting after Fed Chair Janet Yellen's statement, which did little to offset investor uncertainty or encourage on the health of the domestic U.S. economy.

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A trader on the floor of the New York Stock Exchange reacts to news that the Federal Reserve decided to not raise interest rates on September 17, 2015 in New York City.
Getty Images

The U.S. Federal Reserve cited concerns over the global economy and financial market volatility among the factors that played a role in keeping interest rates near zero.

Europe's markets slumped on Friday following a sell off in Japanese stocks and average gains in Asia. The EuroStoxx 600 traded over 2 percent lower. French and German stocks both tumbled in excess of 3 percent in the afternoon trading in the aftermath of the Fed's decision to hold rates.

U.S. stocks followed suit, plunging more than 1 percent pressured by concerns over the implications of the Federal Reserve's decision to leave short-term interest rates unchanged.

"If the Federal Open Market Committee's objective was to convey confusion, it has succeeded, thereby ploughing a deep furrow of instability and destabilization, and shining a very bright light on the large debt and liquidity trap it and other G7 central banks have spent seven years crafting," said Marc Ostwald, strategist at ADM Investors Services.

Speculation on the Fed's move has kept markets on edge for months and, along with China growth fears, has caused severe volatility across most asset classes, with global stock markets losing a hefty $5 trillion of their value in 6 days in August according to Deutsche Bank.

From the summer peak to August low, global equities fell by around 12 percent, mostly in the week leading up to the 'Black Monday' mini-crash on 24 August. Many equity markets fell by 20 percent from their previous highs, putting them in official 'bear market' territory, with China leading the way.

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Now markets are looking to the new "dot path" which details Fed members' projections for interest rates in the world's biggest economy and are studied by traders to try and figure out the future path of interest rates.

The dot plot now shows the path for rates to be more dovish. In June the median dot indicated rates of 1.625 percent by the end of 2016, while the current median dot is at 1.375 percent.

"A dovish and dithering Fed inspires little confidence The Fed's decision to leave rates on hold was not a surprise to a market positioned that way but the tone of the statement and the new lowered 'dot-path' (median sees one hike this year, four in 2016, five in 2017 and three in 2018 for a 3.375 percent Funds rate peak) have dragged Treasury yields down. That is not dollar-supportive," said macro strategist at Societe Generale, Kit Juckes.

"However, any bounce in risk assets will be short-lived," Juckes said, adding that in currency markets, the Yen "could be the biggest winner" if the risk mood sours.

The dollar hit a three-week low against a basket of major currencies on Friday after the Fed's decision, while gold rose to a two-week high of $1,136.

Asia market reaction

In Asia, many economies now expect more market volatility ahead as the build-up to a U.S. rate hike continues.

In Japan, where the Nikkei 225 ended 2 percent down ahead of an extended weekend, Finance Minister Taro Aso told reporters after a cabinet meeting the decision to stay on hold likely reflected opinions of emerging economics voiced at the latest G20 meeting.

The summit of the Group of 20 nations in Turkey earlier this month saw several nations, including the Brazil, Russia, India and China, raise concerns that rapid U.S. rate hikes could cause a global economic slump.

"No doubt low U.S. interest rates have supported growth in emerging economies... but keeping rates below 1 percent for such a long period of time is abnormal," Aso also added.

China's markets, whose turmoil has been a major contributory factor to the Fed's decision, were slightly higher in Friday trading. Hong Kong's Monetary Authority Chief Executive, Norman Chan, also doesn't believe the ultra-low environment in the U.S. is likely to last long.

"I see capital flowing out of emerging markets to Europe and the U.S. [amid signs of rate-normalization], but the pace of outflows from Hong Kong will remain slow," he said.

Meanwhile, the Reserve Bank of Australia Governor Glenn Stevens told a parliamentary hearing that in spite of the inaction this month, the Fed is "probably" on course to raise before Christmas.

"It's also worth noting that the performance in the U.S. continues to improve. Everyone knows that, eventually, this will have to be reflected in less accommodative monetary policy."