The FOMC's 25-basis-point hike roiled fixed-income markets, despite the lack of surprise. China upped – slightly – its forecast for growth next year and stepped up its campaign against real estate speculation as its bond market reacted.
"It's a vote of confidence in the economy"
The Fed: Disturbance in the Force The bond markets reacted strongly to the Fed's 25 basis point (bp) hike on Wednesday,1 with the yield on 2-year Treasuries (the leading edge of market reaction to Fed policy), jumping a significant 10.75 bps to 1.2673% by the end of that day. 10-year Treasury yields also jumped, by 13.95 bps, to 2.5799 during the same interval. Both maturities kept close to that level the following day (Thursday) and into Friday. But 30-year Treasuries rose only 9.89 bps, to 3.1935%, and returned to their pre-hike levels of about 3.13% as of Friday.
Behind the reaction: the upward shift in the Fed's expectations for 2017, both for economic growth and for the number of rate hikes next year, up from 2 to 3. It's worth noting a year ago, when the FOMC hiked its target rate on December 16 (the first time since the end of 2008), the market reaction was similarly strong following a widely-read speech by a voting member of the FOMC forecasting that the Fed would hike rates four times in 2016. That pullback abated only after February 11, when Fed Chair Yellen stated that the FOMC would keep rates low to continue its support of the U.S. economy and help calm global markets.
China: Rising expectations China's economic plans for the year ahead have edged higher, with official forecasts of 2017 GDP growth rising from 6.3% to 6.4% at the conclusion of Beijing's Central Economic Work Conference. Optimism was fueled, at least in part, by an increase in producer prices at the factory gate after four years of declines. China continues to exert selective tightening of credit, however, in recognition of the rapidly-rising housing market; the post-meeting statement included the quote, "Houses are built to be inhabited, not for speculation." Measures include additional limits on flows to banks that lend to speculative real estate purchases and eliminating excess housing supply in third- and fourth-tier cities, Meanwhile, the Fed's rate hike appears to be affecting China's bond markets, with 10-year sovereign yields surging 25 bps this week, the most since December 2014, to 3.35% on Friday Dec 16, along with the one-year yield rising 50 bps and the five-year 27 bps. Money market rates have already been raised as a matter of policy, presumably intended to help cool lending to housing speculators.
Venezuela: Mystery buyer Despite Venezuela's deepening financial and political crisis – or perhaps because of it – a $50,000 US dollar purchase on the Caracas Stock Exchange made after the US election is making headlines as the largest inflow from outside the country in 16 months. In addition to the questions about the identity of the investor, many observers are puzzled about how the foreign investor intends to monetize any potential gains in the face of the punitive official exchange rate of about 10 bolivars to the U.S. dollar for incoming investments, vs. the black-market rate, reckoned to be nearly 4000 bolivars. In order to break even on the trade, the investor would have to achieve a combined equity and exchange rate gain of nearly 400 times, or 40,000 percent.