US: Factors for Fed rate hike and impact on markets - SocGen

Research Team at Societe Generale, lists down the key factors which are responsible for and those which are against the Fed rate hike by end-2016 and their impact on the US markets.

Key Quotes

"For:

• Easier financial conditions: a weaker USD (-4% ytd), tighter credit spreads and a buoyant equity market.
• Solid labour market: nonfarm payrolls recovered in June and July (+292k and +255k respectively).
• External risks receding: economic momentum is improving in EM economies, with the composite PMI rising to 51.7 in July. The short-term spillover effect of the Brexit vote has been limited.

Against:

• Inflation still low: core PCE is still hovering around 1.6% yoy.

• Elections: SG Rates strategists believe the hurdle is too high for a hike before the election, making December the only possible “live” meeting this year.

• China growth decelerating: July data disappointed on all fronts.

Impact for US markets

• Over the past few months, UST yields have fallen to historical lows, while US equities have rallied to record-high levels.

• In the medium term, US 10y rates should stay relatively rangebound, even in the event of a hawkish repricing of expectations by year-end. Monetary easing from other central banks should continue to benefit USTs, as the search for yield intensifies.

• US company earnings were better than expected in Q2. But the sharp increase in valuation ratios (S&P 500 forward P/E 17x, P/B 2.9x) puts the onus on EPS growth at a time when global GDP growth remains uninspiring. A more hawkish Fed could trigger a return of volatility if financial conditions (USD, credit spreads) start to deteriorate again. The S&P 500 fell c.10% following the first rate hike last December.”