Fed should be wary of unintended consequences

Our expectations haven’t changed since the symposium. The most likely outcome we believe is that the Fed embark on a “dovish hikes” theme. The problem with increasing interest rates in the current environment is that risk markets (equities) are far more interest rate sensitive than in previous cycles. The effect of just one 25bp interest rate in December 2015 saw large scale selling of risk assets in January and February 2016 and forced Yellen to step in verbally and soothe markets. There are also unintended consequences of dramatic increases in interest rates namely the strength in the USD (chokes the recovery) and the most likely response from the PBOC devaluing the Yuan further and a re-ignition of problems with emerging markets as a result of large-scale borrowings in USD. The Fed spent 4.5 trillion dollars getting the S&P off the canvas at 666 in 2009, do they really want to unravel this by sending equity markets sharply lower? We expect one increase in 2016 followed by a pause and assess in 2017.