Published On:Wednesday, 18 March 2015
Posted by Chaudhry

Market reaction to Fed rate talk: 3 scenarios


Put away the spreadsheets and stop crunching numbers, because one word is all it's going to take Wednesday to send stock, bond and currency prices gyrating around the globe.
The word is "patient," a term used in written and verbal communications by the Federal Reserve since late last year to tip Wall Street off to the fact that the U.S. central bank isn't in too much of a rush to hike interest rates for the first time in nine years.
But that could change Wednesday if the Janet Yellen-led Fed, when it breaks from its two-day meeting, omits "patient" from its policy statement as many Wall Street pros expect. If it jettisons the now infamous term, it is code for "rate hikes are coming," perhaps as soon as June. The Fed, of course, could stay the course, and reaffirm that it will practice patience and keep rates near zero until later in 2015.
Here are three possible Fed scenarios and how markets might react:
1. Fed drops "patient" language. Hints June rate hike on table.
This is likely the most bearish outcome and most disruptive to markets, investment strategists say. It means rates are likely to move higher in three months' time, which normally gets Wall Street nervous and also runs counter to the market's belief that the Fed "won't be too aggressive," says Bill Hornbarger, Moneta Group's chief investment strategist.
"Anything that contradicts that will likely result in a negative reaction," he says.
In this scenario, which is not a high-probability outcome, U.S. large-company stocks would likely sell off, as the dollar would continue to surge higher against other currencies, such as the euro. An even stronger dollar would put additional downward pressure on earnings of U.S. multinationals. U.S. long-term government bond prices would also sell off, pushing yields higher.
2. Fed drops "patient" language but pledges patience, slow pace.
This would be the most "benign" outcome and cause the least volatility, says Michael Farr, president of money-management firm Farr Miller & Washington. If the Fed maintains that it will move slowly and doesn't telegraph a rate-hike liftoff date, stocks and bonds, for the most part, would likely trade sideways and the dollar's ascent would be more gradual.
"This is the consensus opinion," says Farr. "The silliness surrounding the word patience has gotten out of control. Removing the word "patient" does not mean the Fed will definitely hike in June, and we think a growing consensus understands this."
3. Fed leaves "patient" language in.
"Global markets would rejoice," says Quincy Krosby, market strategist at Prudential Financial.
It would signal a so-called "dovish" Fed, or one erring on the side of keeping rates lower for longer.
"Investors are expecting the Fed to signal either scenario 1 or 2, but not 3," says Nick Sargen, senior investment adviser at Fort Washington Investment Advisors. "Therefore, the biggest market response would be if it kept "patient" in the statement — stocks would fly and bonds would rally." The dollar would likely pull back as well, helping big U.S. stocks that do a lot of business abroad.

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