Stocks Rally After First Fed Rate Hike Since 2006

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After years of waiting, the Federal Reserve finally did it: They raised interest rates for the first time in nearly a decade to end a long experiment with near-zero interest rates going back to 2008.

Specifically, they are going to increase the short-term Federal Funds rate to a range of 0.25% to 0.5% and signaled a further four 0.25% rate hikes to come in 2016 — more aggressive than what the futures market currently projects. It doesn’t seem like much, but it’s a landmark decision that puts the Fed on a tightening path.

And while stocks initially traded lower on the news, the start of Fed chairman Janet Yellen’s post-announcement press conference ignited a rally into the closing bell.

In the end, the Dow Jones Industrial Average gained 1.3%, the S&P 500 gained 1.5%, the Nasdaq Composite gained 1.5% and the Russell 2000 gained 1.5%. The Dow remains in negative territory for the year to date, however, down 0.4%. The S&P 500 is up 0.7% for the year so far.

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Alternative energy stocks led the way thanks to compromises, included in the lifting of the domestic oil export ban, such as the extension of wind and solar power tax credits. SolarCity Corp (NASDAQ:SCTY) gained 34.1%. Energy stocks were the laggards, losing 0.7%. Cabela’s Incorporated (NYSE:CAB) lost 1.9% after suffering an analyst downgrade on valuation concerns.

Treasury bonds weakened, the dollar was unchanged but shaky and gold gained 1.1%. Oil snapped a two-day rise by falling 4.5% or $35.66 after traders responded to an overnight API report showing oil inventories increased by 2.3 million barrels vs. the 1.4 million draw that was expected. The EIA report out today showed a 4.8 million barrel build.

The message from crude oil, gold and the bond futures market is that the Fed has made a policy mistake; that it’s more likely interest rates will be cut in January than hiked further.

But stocks rallied. Why?

Because the computers are programmed that way: Data from NANEX shows a strong positive bias on Fed announcement days (similar to the strong positive bias on nonfarm payroll days regardless of the result). It’s also options expiration on Friday, which means the big banks will be leaning on volatility to ensure the maximum number of options expire worthless.

Another possibility is that investors were soothed by Yellen’s comments stressing the gradual pace of further rate hikes and the emphasis on inflation moving higher.

The Summary of Economic Projections or “dot plot” was largely unchanged, however. The Fed is still looking for short-term rates to be at 1.375% at the end of 2016. But the 2017 and 2018 estimates were lowered slightly, to 2.375% and 3.25% for declines of 0.25% and 0.125% respectively. The long-run rate forecast was unchanged at 3.5% despite the expectation for a drop to 3.25% to reflect structural headwinds to the economy.

The Fed also modestly raised their GDP growth projections for 2016 and lowered their unemployment rate forecast.

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Bank of America Merrill Lynch analysts suggest the outcome of the Fed announcement wasn’t as dovish as many had hoped, since the futures market continues to expect only two rate hikes next year. Already, the Fed’s expectations for four rate hikes next year is well below its historic tightening pace. The more this hawkish outlook is reinforced by steady job gains and an upward progress in inflation, the more the bond market will come under pressure.

Investors have been pleased with rebounds in oil and junk bonds this week. Both are vulnerable to resumption of downward trends in response to the Fed’s actions today: Oil, because of the dampening effect higher rates will have on economic growth and the lift it will give to the dollar. Bonds, because of the negative impact weaker energy prices and a stronger dollar will have on corporate earnings growth.

As the calendar flips into 2016, Alberto Gallo at RBS worries that the Fed will have a tough time living up to its four hike forecast amid policy divergences with the likes of the Bank of Japan and the European Central Bank and the currency and bond market volatility that’s likely to result.

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For investors, I continue to recommend precious metals here, as the Fed continues to say it wants inflation to increase before hiking further. A group of gold and silver stocks recommended to Edge subscribers including First Majestic Silver Corp (NYSE:AG) gained 5.4% today while Edge Pro subscribers enjoyed a big gain in their Barrick Gold Corporation (NYSE:ABX) calls.

Anthony Mirhaydari is founder of the Edge and Edge Pro investment advisory newsletters. Free two- and four-week trial offers have been extended to InvestorPlace readers.

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Article printed from InvestorPlace Media, https://investorplace.com/2015/12/stocks-rally-after-first-fed-rate-hike-since-2006/.

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