Fed U-turn underpins New Year rally

Tom Stevenson

Tom Stevenson - Fidelity Personal Investing

Sometimes bad news is good news. That was certainly the case last night, when cautious comments from the Federal Reserve raised a cheer from stock market investors. A strong performance on Wall Street spilled over into Asian markets and set the scene for a cheerful end to January in Europe too.

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The reason investors have regained their appetite for riskier assets like shares is simple. The Fed’s nervousness about global growth means it is now very likely to leave interest rates on ice for the time being. Markets like lower interest rates because they lower the cost of borrowing for companies and households and so boost growth.

They also tend to lead to a weaker dollar, which is normally good news for emerging markets (where borrowings are often denominated in dollars). Both emerging market shares and bonds have enjoyed a strong rally since the turn of the year.

This is a major U-turn by the US central bank. As recently as December, its chairman, Jerome Powell, spooked investors by suggesting that he remained committed to tightening monetary policy despite the significant downturn in markets in the fourth quarter of 2018. Last night he seemed to backtrack on that on two fronts - referring to a ‘patient’ approach to raising interest rates and a more cautious approach to reversing the bond buying stimulus that has also boosted markets in recent years.

Last night, the S&P 500 index, the main benchmark for US shares, rose by 1.6% to 2,681. That compares with a low around Christmas of 2,351. In Asia, Japan’s Topix index rose by as much as 1.4%. The Hang Seng index in Hong Kong was 1% higher and Chinese mainland shares also rose. In early trading in Europe, the FTSE 100 was 0.6% higher, adding to strong gains in the two previous sessions.

The rally in shares ensures that January will end up being a positive month for stock markets around the world. This will please followers of a well-known investment adage, the so-called January barometer. This says that a strong first month of the year in markets tends to lead to a strong year as a whole, although the evidence for this is actually rather patchy.

Not everyone has welcomed the Fed’s new approach, with some worrying that the policy U-turn has been triggered by market turmoil and pressure from the US President (who has criticised recent rate hikes) rather than any substantive change in the outlook.

Anna Stupnytska, Fidelity’s global economist, said: ‘I believe this shift will come to haunt the Fed later in the year when the economic backdrop will most likely necessitate more hikes, not cuts’.

This week, employment data in the US are likely to show that the US economy remains in good shape despite the recent shut-down of the Government in Washington. Last night’s statement by Mr Powell did not provide much clarity on exactly why he has changed tack so abruptly.

For now, however, investors are likely to welcome the apparent calming of last autumn’s market volatility and be glad that the Fed chair seems to have an eye on the markets as much as inflation and growth.

With lower interest rate expectations providing support for both shares and bonds, investors have all the more reason to adopt a balanced approach to their investments. Fidelity’s Select 50 Balanced Fund is designed to diversify its exposure to both of these asset classes. Using the Select 50 list of our favourite funds as its starting universe, it also has a focus on quality, which is important when there is so much uncertainty in financial markets.

Learn more about the Fidelity Select 50 Balanced Fund.

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