Market Implications of Latest Fed Hold

The US Federal Reserve's decision not to hike interest rates on September 17 is bearish for US stocks, in our view. Rate markets are now pricing in only a 45% chance of a hike by December, meaning that the wall of worry which markets like to climb is no longer in place, and a rate hike by end-2015 could come as a negative shock. Moreover, the hold raises the prospect that the window of opportunity for hikes will close and the Fed could be forced to hold off for much longer amid renewed financial market weakness. This could erode the Fed's credibility and could undermine belief in the central bank's ability to positively impact the market or the economy with monetary policy.

Technically, the S&P500 has retraced just over one half of its fall from the peak, and the weak close following the Fed's decision raises the risk that the recent move higher has been a bear-market rally. The action in the VIX index also suggests that fear has subsided sufficiently for renewed selling to begin.

At the same time, the US dollar is likely to come under renewed pressure, supporting emerging market currencies. We argued previously a bullish case for EM FX, and by implication EM equities, and the fall in US real bond yields following the Fed meeting supports this view. Additionally, the move is a net positive for commodities, which have already been showing some signs of basing. Brent crude oil has broken out of its short-term wedge to the upside, suggesting further near-term gains, in line with our fundamental view for higher prices.

These factors provide support for the outperformance of EM equities relative to the US over coming months.

Our full analysis of global financial markets is available to subscribers of our online platform and Daily Alerts.