US rate hike: Fed can't ignore global markets

Global equity markets rallied on Thursday following reassurances from the US Federal Reserve that it would not raise interest rates next month as it had planned; however, the release of strong US GDP figures has thrown this into question.

On Thursday fresh economic data showed that the US's gross domestic product (GDP) grew by 3.7% year-on-year in the second quarter, up from initial estimates of 2.3% and beating market forecasts by around 0.5%.

The news proved a contrary signal to a statement from New York President of the Federal Reserve William Dudley, who said on Wednesday that a US interest rate rise in September seemed "less compelling" than earlier in the month, due to turmoil in global markets spurred by concerns over China.

In recent years bullish signals from the US economy have proved negative for global markets, as investors fear the withdrawal of the Fed's equity positive $4.5 trillion (£2.9 trillion) quantitative easing programme.

Commenting on whether or not the Fed will in fact hold rates at their current 0.25% level in the face of stronger domestic data, Kully Samra, managing director of Charles Schwab UK, says: "The US economy is looking increasingly robust at the moment with economic growth up, unemployment down and the US consumer making a comeback. However, the Fed can't ignore what is going on in global markets. I wouldn't say that a rate rise in September is completely off the table, but it is looking less likely."

However, John Higgins, chief markets economist at Capital Economics, is less sure, adding that the Fed has historically been undeterred by weak global equity prices when it comes to an interest rate hike. "We doubt the recent plunge in global equity prices, which in any case has shown signs of reversing, will have a major bearing on the Fed's decision next month," he says.

"There are plenty of times when the Fed has eased policy in response to a slump in stock markets in order to cushion the US economy. It is harder, though, to find episodes when lower equity prices have caused the Fed to refrain from tightening," he adds.

Market response

Initially undeterred by the stronger data, US markets continued to recover from Monday's rout on Thursday, with the Dow Jones Industrial Average closing up 2.3%. European markets also continued Wednesday's rally, with the UK's FTSE 100 index closed more than 3% higher at 6,192.

However, on Friday European markets were more subdued, with the UK's FTSE 100 trading flat and Germany's Dax and France's Cac 40 both down around 0.5% by lunchtime. In contrast, Chinese markets enjoyed a strong finish.

Commenting on Friday trading, Alastair McCaig, market analyst at IG, says: "As what feels like a very long week winds to an end, China's Shanghai Composite has closed up 4.82% on the day; however even with the last couple of days' worth of bounce it still sits some 40% off its summer highs.

"Considering the volatility that we have seen this week and the fact we are about to embark on a long bank holiday weekend, it is no real surprise that UK traders are taking the opportunity to unwind positions."

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