The Market Has No Need to Fear The Fed, Merrill Says

       

By Paul Vigna
        The Federal Reserve wants to raise interest rates. If you didn't know that, you've been living under a rock, without wifi, for the past two years. This reality has, from time to time, cause some amount of distress among market types.
        It needn't, the group at Bank of America/Merrill Lynch said.
        "After more than six years of near-zero rates, will the economy be able to handle higher rates? Should the Fed wait until 2016 as the IMF suggests?" the group wrote in a research piece on Friday. "If our strategists are right, the shock to the markets and economy should be quite small."
        For one thing, they note, the dollar has already been moving in anticipation of the Fed's first rate increase (something that has been abundantly clear to every forex trader from London to Sao Paulo to Singapore). The dollar rose 14% from July 2014 to March 2015, they point out, and predict that it will gain only another 3% from here until the end of 2016.
        They also think all the QE programs from other central banks will offset whatever monetary tightening the Fed undertakes. "Our rates team expects the 1o-year yield to rise to just 2.85%, not even hitting the taper-tantrum highs," they said. That's only about 60 basis points away from the current yield on the 10-year Treasury, which sunk to 2.20% in the wake of the employment cost index report.
        The group also sees single-digit returns for stocks in the next year, home-price inflation of only about 2.4%, and steady growth in bank lending.
        Normally, the firm notes, the markets handle rate hikes just fine. In five of the past six times when the Fed started raising rates, the market was higher a year later. While this current monetary regime is rather different from past cycles - in its entire history, the Fed has never cuts rates to zero, forget about leaving them there for seven years - they believe the Fed will adjust policy to reflect that reality. The expect the Fed will move only about half as fast as it has in previous tightening cycles.
        "They are carefully telegraphing their intention to go slow. They are promising to maintain a big balance sheet until they are sure the rate hikes are being comfortably absorbed."
        (END) Dow Jones Newswires

        July 31, 2015 12:26 ET (16:26 GMT)

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