The S&P 500 rose nearly 3% last week as investors reacted positively to the Federal Reserve’s announcement that suggested rate increases would be slower and end sooner than previously projected. Small cap stocks performed in line with the S&P 500, and international stocks rose nearly 4%. Nine of the ten sectors produced positive results last week; only basic materials stocks declined. Rates declined slightly and the 10-year Treasury yields fell to just below 2%.
Will They, or Won’t They
About every six weeks, (eight per year) the Federal Open Market Committee (FOMC) meets to discuss the monetary policy of the United States. Typically, the stock market reacts on the news from these meetings and what has been said in the meeting minutes. Sometimes there is not much volatility as a result, and sometimes, it seems the market dissects every word that was said and you can see huge swings in the market, either up or down. Right now, we are definitely in the latter stage. For the last several meetings, everyone has been wondering when the committee will raise U.S. interest rates, and more specifically when they will remove the word “patient” from their vocabulary. In past scenarios, when the FOMC removes the word “patient,” it is a signal that they will begin to raise rates in the very near future. This was last done in May of 2004, and by June of 2004 they were deciding to raise rates.
Well, they did it. The FOMC removed that fateful word in the last meeting on March 18. Many would guess that the markets would react negatively, because of the tightening signal that was just presented. But, the opposite happened. Markets rallied late in the day on the news. Why? Even though “patient” was removed, the meeting still had a “dovish” tone. The FOMC cut their GDP forecasts and the inflation outlook was downgraded. Even though “patient” was dropped, the market perceived this as the Fed is still waiting for clear signals to raise rates.
Many now expect rates to rise in September or later, although June is still on the table. With the market listening closely on every word said in every meeting, we expect much more volatility to come in 2015.
British Politics Resurface as a Market Risk
British politics are once again having an affect on the markets. On May 7, the Conservative-led coalition government, headed by David Cameron, will face voters. The market implications for this election are more complicated than usual. Normally, the Conservatives would be the most reassuring choice for investors. However, Cameron has promised a referendum on whether the United Kingdom will remain part of the European Union (EU). Britain has been an EU member since the 1970s, but didn’t continue down the path of joining the Euro currency.
Exiting the EU would put the United Kingdom in danger of losing preferential trade access to European markets, which are the destination for 50% of British exports. Britain’s role as a financial hub could also be affected. Similar risks affect European exports to Britain. The Labour Party, while less friendly to business, favors EU membership.