Dollar increases on Fed rate rise bets

Warren Buffett: U.S. Federal Reserve is the ‘biggest hedge fund in history’

Equities are calm, taking in their stride the US central bank’s confirmation it is finishing the third multibillion-dollar asset purchase programme, or QE3, that many investors considered a crucial support for stock markets.

Gold is falling and short-term US bond borrowing costs are holding at three-week highs as traders bet the Federal Reserve may start raising interest rates sooner than the market had expected. The FTSE Eurofirst 300 is opening up 0.5 per cent and US index futures indicate the S&P 500 will add 2 points to 1,984, in line to leave Wall Street’s benchmark less than 1.5 per cent shy of its record close hit in September.

As the two-day meeting came to a conclusion last Wednesday, the Federal Open Market Committee not only announced the end of QE3 but also highlighted an improvement in the US labour market and gave itself room to raise rates if the country’s economy grows faster than it expects.

“The gradual Fed normalisation is a result of a strengthening economy,” said Gary Yau of Crédit Agricole.

But the Fed’s comments also have been deemed slightly more aggressive than investors had forecast, causing analysts to reconsider the timing for when US interest rates will start rising from record lows.

“With the rates market fully priced for October 2015 as the first Fed Funds hike, we expect this in part to be brought forward should US data remain on trend,” said Richard Cochinos, CitiFX G10 strategist.

“What has tripped the markets is the fact that there was no mention by the FOMC of recent financial volatility and no concern about the weakness of market inflation expectations,” said Lena Komileva, chief economist at G+ Economics.

“The Fed is clearly more confident about economic risks than investors are, which will add a risk premium to the market price of liquidity and volatility, via a stronger dollar and higher US rates,” she added.

Indeed, US bond prices took a dive in the wake of the Fed statement and those levels are mostly being held on Thursday. The US 10-year yield, which moves inversely to the price, is 1 basis point softer at 2.31 per cent and the more policy-sensitive 2-year yield is barely changed at 0.49 per cent, the highest in three weeks.

The dollar is stronger in response, its trade-weighted index up another 0.4 per cent to 86.24, placing it about 0.5 per cent below its highest level since June 2010.

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