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 Fed Chair Janet Yellen on Friday said she expected the U.S. central
bank to raise rates in 2015, though the process was expected to be
gradual, with the timing of the first hike dependent on the strength
of economic data.
Yellen's comments kept the likelihood of a September rate increase
high. Currently, most economists expect lift-off in September,
though dealers are not especially convinced of it. Market indicators
put the first increase closer to the end of the year.
Recent data has been mixed. Some weak reports have pushed back the
expected lift-off, but Yellen's words suggest the Fed is still
headed to rate increases later this year.
"I thought the message was, 'if things stay like this, like they are
today for a few more months, rates are going up.' And that is
probably the correct policy call," said Stephen Massocca, chief
investment officer at Wedbush Equity Management LLC in San
Francisco.
When the Fed does raise rates, that will mark the first increase
since 2006 and end a roughly six-year stretch of near-zero interest
rates that has helped the stock market rally broadly to new records.
It has also kept a lid on long-term rates. The expectation that the
Fed will raise rates soon, but keep the pace gradual, has been a
boon for short-term rates and long-term rates, but less for the
middle of the U.S. Treasury yield curve. Five-year notes, which
outperformed earlier this year, have lagged lately.
"We are of the camp that this rate cycle will be low and slow. The
remarks from Yellen confirmed that," said Collin Martin, director of
fixed income at Schwab Center for Financial Research in New York.
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Analysts expect the Fed to move slowly and communicate its
intentions often to avoid a "taper tantrum" of the variety caused by
former Fed Chairman Ben Bernanke in mid-2013, when Bernanke
surprised markets by suggesting the Fed could soon reduce stimulus.
The Fed has let the federal funds rate drift higher, to around 11 to
12 basis points most of this year, from 9 to 10 basis points most of
last year.
According to Bespoke Investment Group in Harrison, New York, in the
three months after the Fed raises rates following a year of keeping
them steady, the S&P 500 falls an average of 2.27 percent.
The market reaction this time could be amplified given valuation
concerns. The S&P's forward price-to-earnings ratio is 17.5, well
above the long-term average of 14.8, Thomson Reuters data showed.
"We are a little overvalued, even with interest rates low," said
Donald Selkin, chief market strategist at National Securities in New
York. "There could be some choppy seas ahead, especially if oil
prices stay low or the dollar remains strong."
(Additional reporting by Chuck Mikolajczak and Richard Leong in New
York; Editing by Nick Zieminski)
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