Skip to main content

Once again, the Federal Reserve has upended markets.

Investors had been bracing for the Fed to keep raising interest rates and shrinking its vast portfolio of assets, the equivalent of tapping on the brakes of the U.S. economy.

But this year, the central bank has signaled that it was backing off.

Story continues below advertisement

Much has been written about the stock market’s joyful reaction to the Fed’s altered approach. But the effect was much broader than that. The central bank’s shift cascaded through markets around the world in ways large and small.

Here’s a look at the consequences of the Fed’s new tone.

Stocks

The Fed’s change of heart helped halt and partly reverse December’s brutal stock sell-off. On Dec. 24, the S&P 500 was down nearly 20 per cent from its recent high.

After Fed chairman Jerome Powell began on Jan. 4 to espouse the virtues of patience and flexibility, the market turned sharply higher. The S&P 500 is now up about 15 per cent from its nadir in December.

Stocks of companies that are sensitive to changes in interest rates have climbed at especially speedy clips. Shares of homebuilders, for example, are up more than 17 per cent since the market low in December. That suggests the Fed’s shift has been a big reason for the market’s recent pop.

“I think the Fed’s turnaround has been vital to the recovery that we’ve seen in equity markets,” said Tony Roth, chief investment officer at the wealth management firm Wilmington Trust.

Bonds

In December, stress started to build in the market for corporate bonds. Investors balked at putting money in anything other than super-safe government bonds. One sign of this was a widening of “credits spreads” — the difference between the relatively low yields on government bonds and the relatively high yields on corporate bonds.

Since Jan. 4, when the Fed’s swivel began, those credit spreads have fallen sharply. That is largely because the yields on corporate bonds have declined, while those on government debt have barely budged.

A big reason for the drop in corporate bond yields is that investors have greater confidence in the U.S. economy and the ability of U.S. companies to remain financially healthy.

Currencies

One way to think about the short-term interest rates that the Fed sets is that they are the rates at which investors — or even people with savings accounts or certificates of deposits — get paid for holding U.S. dollars. When the Fed raises rates, and other central banks don’t, those higher U.S. rates attract capital from around the world. The influx of money pushes up the value of the dollar relative to other currencies.

Last year, as the Fed raised interest rates four times and appeared ready to continue in 2019, the U.S. dollar rose about 10 per cent relative to the euro and other major currencies.

The rising value of the dollar has big implications.

It makes U.S. manufactured goods more expensive, and therefore less competitive, on the world market. It depresses the overseas earnings of U.S. companies when they get converted back into dollars.

Story continues below advertisement

And it reduces the prices of commodities, many of which are priced in dollars on global markets. (All else being equal, if the dollar’s value rises, you need fewer dollars to buy the same barrel of oil or ton of iron ore.) The rise in the value of the dollar, along with a supply glut in the world’s oil market, helped push crude oil prices down by more than 40 per cent from October to the end of December.

When the Fed signaled that it was backing off further rate increases, that slowed the upward momentum of the dollar. In fact, it appeared to put a ceiling on the dollar’s rise, at least for now.

That, in turn, is likely to help U.S. companies and strengthen commodity prices. Crude oil prices are up 16 percent in 2019.

Emerging Markets

A weaker dollar is also a boon to emerging markets, whose economies often rely on exporting commodities and borrowing money from foreign investors.

The weak dollar helps on both counts. With higher commodity prices, it becomes easier for commodity-producing countries and companies to pay off loans, which foreign investors often require to be repaid in dollars.

This is a reversal of the 2018 trend, in which the strong dollar provoked a run on emerging markets like Turkey and Argentina, causing the value of their currencies to drop. Money now is flooding back to those developing economies, propelling stock markets in Turkey, Russia and Brazil.

Story continues below advertisement

The Future

The question is how durable this relief rally will prove. Even with the Fed’s pro-economic-growth stance, there are plenty of remaining risks to the global economy — and therefore to financial markets. Chief among those is the possibility that huge economies in China, Japan and Germany sputter.

“The Fed has applied a Band-Aid onto a broken arm,” said Frances Donald, head of macroeconomic strategy at asset manager Manulife in Toronto. “This is enough to give us a moment to alleviate our worst concerns. But it doesn’t solve the underlying problem, which is a sizable growth slowdown.”

Report an error
Tickers mentioned in this story
Unchecking box will stop auto data updates
Due to technical reasons, we have temporarily removed commenting from our articles. We hope to have this fixed soon. Thank you for your patience. If you are looking to give feedback on our new site, please send it along to feedback@globeandmail.com. If you want to write a letter to the editor, please forward to letters@globeandmail.com.

Welcome to The Globe and Mail’s comment community. This is a space where subscribers can engage with each other and Globe staff. Non-subscribers can read and sort comments but will not be able to engage with them in any way. Click here to subscribe.

If you would like to write a letter to the editor, please forward it to letters@globeandmail.com. Readers can also interact with The Globe on Facebook and Twitter .

Welcome to The Globe and Mail’s comment community. This is a space where subscribers can engage with each other and Globe staff. Non-subscribers can read and sort comments but will not be able to engage with them in any way. Click here to subscribe.

If you would like to write a letter to the editor, please forward it to letters@globeandmail.com. Readers can also interact with The Globe on Facebook and Twitter .

Discussion loading ...

Cannabis pro newsletter