World markets poised for US Fed rate hike

The US Federal Reserve building in Washington DC. Photo / 123rf

Financial markets and home owners face a key point this week if the US Federal Reserve conforms to expectations and raises its official interest rate.

In a sense a rate hike has already happened - US 10 year bond yields have spiked to 2.6 per cent, near the top of a 12-month range - and the US dollar has rallied sharply.

The return of the greenback has put sharp, downward pressure on the kiwi, which has dropped by just over US3c, or 4.2 per cent, in less than a month.

A surprise drop in dairy prices, alongside a string of mixed economic data, has also eroded the Kiwi's value.

A two-day meeting by Federal Reserve policymakers is under way and a decision is expected early on Thursday morning (NZ time).

Financial markets have fully priced in quarter of a percentage point hike in the fed funds rate to a range of 0.75 per cent to 1 per cent.

The central bank is also expected to confirm its "dot plot" plan, which entails two more rate hikes over the remainder of the year.

The wild card for Fed watchers will be the extent to which the central bank factors in the likely impact of US President Donald Trump's economic policies, which involve lower taxes and higher spending on infrastructure.

"If the Fed was to hike this week, and they stuck to the (dot plot) script, then you might not see much of a currency reaction, but the focus really turns now to what they say and what they project, in addition to that," ANZ senior economist Phil Borkin said.

"The global interest rate environment is shifting and mortgage rates are moving because of that," he said.

Locally, deposit growth is not matching credit growth, which means banks are looking to offshore for funding.

New Zealand interest rates are on the move - US 10 year bond yields last traded at 3.15 per cent from 2.15 per cent last August.

A US rate hike at this point would serve as a signal that the financial markets are on track to more normal conditions after a prolonged period of abnormally low rates following the Global Financial Crisis.

"My sense is that we will not get any pressure on mortgage interest rates (from the rate hike) in the near term, but that we are likely to get it through the course of the year," Mark Brown, fixed interest portfolio manager at Harbour Asset Management said.

Analysts said Trump's policies, which would lead higher growth and higher inflation, could lead to a more aggressive stance from the Federal Reserve.

"If you add those to current projections then you have got an argument for higher rates in the US," he said.

"If that was to be the case, then expect longer term rates to rise in New Zealand as well," Brown said.

Financial markets around the world have been in lock down mode this week before the results of the Federal Reserve's Open Market Committee meeting are made known.

Aside from the Fed, rate decisions are expected form the Bank of England and the Bank of Japan. Markets will also be watching for the Dutch election result.

Domestically, local financial markets will be looking to Thursday's release of December quarter GDP data, which is expected to show the economy grew by 0.7 per cent over the quarter.