Global markets have priced in Fed rate hike: Morningstar

Devika Ghoshmoneycontrol.comGlobal financial markets have been buffeted by a series of developments - Greece bailout, China market crash, crude oil crash - over the last few months, and the storm is far from over. The most keenly watched event over the next few weeks will be the US Federal Reserve's action on interest rates. The consensus view on the first rate hike is September, but many market watchers also feel that before the year is out, the world may see two rate hikes.

Looking at the generally upbeat mood in global markets, it appears a sense of complacency may have set in. But Francisco Torralba, Senior Economist for Morningstar Investment Management, says markets are not being complacent about it. "The markets continue to price a shallow path of monetary tightening, starting sometime between September and December FOMC meetings. That is what the Fed has led the markets to think," he told moneycontrol.com in an e-mail interview.

The Fed has time and again assured the markets that it won't do anything that will have a potential negative impact. "The Fed, under Janet Yellen, has been at pains to communicate its intentions and will continue to do so during August and September to ensure nobody is surprised on September 17, whatever the FOMC decides to do then," he says.

His confidence on the impending Fed action comes through when he says that the Federal Reserve wouldn't even contemplate raising rates if it thought that the markets hadn't priced the tightening correctly.

However, he adds that it is an altogether different story whether the financial markets have comprehended the effects of a rate hike. Torralba believes the markets are too anxious, and not complacent at this stage.

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Francisco Torralba

Senior economist|Morningstar Investment Management

He, however, fails to understand the chatter surrounding the same. "The Fed raised rates a dozen times between 2004 and 2006 (the most recent tightening cycle) without cooling the bullish equity market," he exclaims.

Going by history, he finds it difficult to discern a correlation between a rise in the Fed’s policy rate and returns. "I think the most likely reason why the Fed didn’t seem to disturb the markets is that most of the time the rate hikes were anticipated. Supporting this hypothesis is the tightening cycle of 1994, which was steeper and earlier than markets had anticipated. As a result, almost all asset classes suffered losses," he adds.

Impact of Fed rate hike on global fund flows:

"The Fed’s decision should have no significant impact on global fund flows, because it has already been priced in," says Torralba. Sure, there would obviously be a few hiccups and wobbles post the announcement, but the FOMC will reassure everyone that it won't raise rates more that strictly afforded by the economic data. It may even take a rather dovish view of the data, he adds.

He says if the outlook for the Federal Reserve monetary policy and other major central banks pan out, he expects inflows to the US equity market to continue, and US equity valuations to get pushed further up.

Fall of the dragon?

The other important news maker has been the Chinese market meltdown. While the government somehow managed to contain the extent of the crash, the problems or issues plaguing the market are far from over, says Torralba. "Excessive investment and overcapacity have not been corrected. Recurrent bubbles reflect the tension between free markets and Beijing’s dirigisme," he says.

China’s measures to support the stock market will not succeed for long, because price controls rarely work, he adds. The only strategy that might work is an unlimited commitment by the People’s Bank of China to buy stocks (with freshly printed money), he opines.