Interesting times: financial world awaits as Fed chair Janet Yellen weighs up implications of a rate hike
Some believe a rise is inevitable and is long overdue, while others think such a move would be “premature” and could set back the fragile economic recovery witnessed over the last few years
With a collective intake of breath, the financial world is once again waiting for the US Federal Reserve’s next pronouncement on whether they will – or won’t – increase US interest rates by a fraction of 1 per cent.
A familiar pattern now precedes each episode of this long-running cliffhanger, with bankers and investment
advisers all ready to give their two cents worth on the quantum, timing, required conditions and impact of any upward move.
In short, everyone knows rates will have to rise from their present historic lows. But even with the US economy adding a further 151,000 jobs in August and unemployment holding steady at 4.9 per cent, many still counsel caution, fearing that a “premature” rate rise could put the brakes on the hard-won recovery of the last few years.
Against that, though, is the view that a return to normality is past overdue.
Not too surprisingly, formal comments made by Fed chair Janet Yellen at a late August symposium in Jackson Hole, Wyoming gave no more than the usual clues. However, it was noted that key conditions for a rate increase include positive leading indicators, the US economy moving towards full employment, and wage growth continuing to accelerate. So, clearly, the next move cannot be too far away.
“Yellen did not commit to a timeline for the rate hike, despite acknowledging that the case for an increase has strengthened in recent months,” says Christian Nolting, global chief investment officer for Deutsche Bank Wealth Management. “She also highlighted that any rate hikes will remain gradual.”
Interpreting this, Nolting suggests the federal funds target rate could be lifted twice over the next 12 months, with the growing probability of a first move before the US presidential elections in November. That would tie in with the potential for further easing by other major central banks.
In parallel, he also sees some room for US dollar strength in the coming months and the likelihood of increased volatility in equities. “Markets have grown too complacent about Fed movements,” he says. “However, ongoing economic uncertainty as a result of structural issues – such as productivity, a China slowdown and credit creation – plus demographics and geopolitical tensions are the reasons we believe the Fed could remain very slow and cautious in raising interest rates throughout this cycle. Current fiscal conditions limit any grandiose policy moves.”
For Ernest Chan, head of investment management services at Morgan Stanley Private Wealth Management Asia, the possibility of a rate increase following the Fed’s September meeting is receding. In fact, he assesses the chances as “very low”.
His logic is that, this year, growth in core personal consumption expenditures inflation is set to come in below the Fed’s 2 per cent goal for the eighth straight year. The most recent year-on-year peak in this gauge, which was recorded in January, was 1.7 per cent.
“We believe there may be no rate hike at all this year,” Chan says. “It may only come in late 2017 or even 2018.”
A consequence for private investors, including the high-net-worth segment, is that related yields are unlikely to pick up significantly, leaving only limited value in investment grade fixed-income products, even as the global economy shows ongoing signs of recovery.
“Most investors are either sitting on plenty of liquidity or are in fixed-income assets,” Chan says. “However, since August, we have seen relatively slower momentum into fixed income as many investors are waiting for a clearer picture to emerge from September’s FMOC’s [Federal Open Markets Committee] meeting. We have also seen some profit-taking, with some high-net-worth clients switching into higher-yielding emerging market paper or floating-rate notes.”
While not dismissing completely the possibility of one or even two rate hikes later this year, Chan suggests the only real concern would be the short-term profit and loss impact for fixed-income investors who are more highly leveraged.
In other respects, his view is that US equities, though still attractive, are in the latter stages of a cyclical bull market. But emerging market stocks (EM), which have disappointed in the last few years, could be ready to turn the corner.
“As long as the US dollar and oil prices remain close to current levels, EM equities could continue to outperform,” Chan says. “The [Asia] region now offers better value.”