February 6, 2018 / 10:28 PM / 3 months ago

Fed seen staying on rate-hike path after stock market plunge

NEW YORK (Reuters) - Monday’s rout on Wall Street frayed investors’ nerves, but it is not enough to knock the Federal Reserve off course from its intended path to further raise interest rates in 2018 as the economy continues to hum along, analysts say.

FILE PHOTO: The Federal Reserve headquarters in Washington September 16 2015. REUTERS/Kevin Lamarque/File Photo

The worldwide market sell-off in equities wiped out $4 trillion in value from record peaks eight days ago, raising concerns such a swift loss of wealth would hurt corporate investments and consumer spending just when many economies in addition to the United States are on a synchronized growth path.

Stocks recovered on Tuesday a fraction of what they lost over the prior two trading sessions, but the price declines and rise in bond yields does relieve a bit of the pressure on the Fed to raise rates.

While investors are smarting from the sell-off, financial conditions, or levels of wealth and borrowing costs, remain at their strongest in almost 25 years. They, together with the major tax cuts enacted in December, would support the economy to grow 2.5 to 3.0 percent, analysts said on Tuesday.

Unless the market plunge intensifies and damages the economy, Fed policy-makers will unlikely budge from their plan to lift key short-term interest rates three times this year, analysts said.

“I don’t think what we have seen would change their view on their path of rate hikes,” said Daragh Maher, U.S. head of FX strategy at HSBC Securities USA Inc. in New York.

(Graphic: Traders See Less Aggressive Fed after Wall Street Plunge - reut.rs/2BK7RgB)

FED RATE BETS

Still, traders dialed back bets the U.S. central bank would ratchet up the pace on rate increases on Monday to between two to three hikes from three to four hikes, according to interest rates futures.

Last Friday, traders added to their positions for a faster pace of rate hikes when a robust payrolls report showed wage pressure grew to 2.9 percent in January, the fastest annual rate since June 2009.

Anxiety that inflation is accelerating due to bigger paychecks propelled benchmark 10-year yields to a four-year high at 2.88 percent.

Concerns that rising wage pressure would eat into corporate profits and the Fed would raise rates more quickly to raise borrowing costs led to a stampede out of stocks.

Wall Street’s three major indexes rebounded following Monday’s drop.

But the S&P 500’s gains so far in 2018 evaporated, while the Dow was in negative territory for the year. The Nasdaq clung to a 2.8 percent rise but was well below an 8.7 percent increase on Jan. 26.

FINANCIAL CONDITIONS STILL EASY

In addition to signs of rising inflation, loose financial conditions will be a key factor for the Fed policy-makers to raise short-term rates further.

Rates futures suggested traders expected the Fed would raise rates by a quarter point at its March 20-21 meeting. It raised rates back in December to a target range of 1.25-1.50 percent.

“Financial market conditions are part of that calculus,” said Kristina Hooper, chief global market strategist at Invesco in New York. “Nothing I have seen so far would cause the Fed to change.”

The Chicago Federal Reserve’s index on financial conditions, which account for the state of money, debt and stock markets as well as borrowing costs, slipped to -0.94 in the week ended Jan. 26, which was the lowest level since August 1993 and signaling extremely easy market conditions.

For now, the Fed will likely monitor whether inflation is indeed accelerating toward its 2-percent goal, or just a specter that induces a short-lived market sell-off.

“The Fed will keep their eye on the prize - which is inflation,” Hooper said.

(Graphic: U.S. Financial Conditions Still Loose after Wall Street Rout - reut.rs/2BHMs7A)

Reporting by Richard Leong; Editing by Daniel Bases and Susan Thomas

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