As expected, the US central bank pushed rates up another notch yesterday. Here are some reactions from the wealth industry.
The US Federal Reserve, now under the chairmanship of Jerome Powell, has as expected nudged interest rates higher, taking monetary policy slowly back towards more “normal” territory after almost a decade of negative real rates. As at the time of writing, investors appear not to be unduly rattled.
The Federal Open Market Committee increased the range of its target rate by 25bps [basis points] to between 1.50 per cent and 1.75 per cent.
Here are some of the reactions since Asian and European markets opened for business today. More reactions may be added during the day:
Tiffany Wilding, US Economist, PIMCO
“The faster pace of rate hikes likely reflects a brighter near-term outlook for US growth. Over the last few months, several FOMC participants have emphasized that the economic headwinds restraining growth in previous years have now turned to tailwinds. Since the December FOMC forecast update, congressional leaders achieved a sweeping rewrite of the tax code and a two-year government spending deal, which together should raise US real GDP growth by a little more than half a percentage point in 2018 and 2019, according to our estimates.”
These more expansionary fiscal policies have occurred against the backdrop of largely diminished US labor market slack, a synchronized recovery in global activity and easier financial conditions, which have lifted US exports and business investment growth.”
“A more prolonged period of above-trend growth should further tighten labor markets and support inflation - perhaps even garner a modest inflation overshoot, as several FOMC officials now forecast - which argues for a somewhat faster pace of rate hikes.”
Charles St-Arnaud, senior investment strategist at Lombard Odier Investment Managers
“The tone of the statement was relatively bullish, with the FOMC acknowledging `the economic outlook has strengthened in recent months’. The FOMC also reiterated, as expected, that `economic conditions will evolve in a manner that will warrant further gradual increases in the federal funds rate’.
However, the focus for investors was the January Summary of Economic Projection. As expected, the growth forecast for 2018 and 2019 rose to 2.7 per cent and 2.4 per cent respectively, reflecting the strengthening in the economic outlook and the impact of tax cuts. As a result, the unemployment rate is expected to decline further to 3.8 per cent in 2018 and 3.6 per cent in 2019 and 2020. Despite the stronger growth, core CPI is only expected to be 0.1 percentage point higher in 2019 and 2020.”
“The main surprise for many investors was that the FOMC continued to expect three hikes this year rather moving to four hikes. Many investors would have expected that the Fed would have upgraded its view given the stronger growth, the lower expected unemployment rate and improved economic outlook. This could be because some of the FOMC members may have wanted to delay somewhat their decision to upgrade their view on rates to avoid being seen as pre-committing to four hikes so early in the year and painting themselves into a corner.”
“Our view remains that the Federal Reserve will hike its policy rate by three more hikes this year, as we believe that inflationary pressures are building up in the US.”
Jack McIntyre, portfolio manager of the Brandywine Global Fixed Income Fund
“We have maintained the Fed will not act aggressively this year because officials are aware that tightening too quickly could negatively affect equity performance. Ultimately, we think signaling three rate hikes gives the Fed an option to change the pace of tightening later in the year if necessary. The Fed did raise its target for the median fed funds rate in both 2019 and 2020, increased its gross domestic product (GDP) growth forecast, but left its inflation outlook unchanged. Since there still has not been a meaningful uptick in inflation yet, we have continued to maintain that the Fed will not act aggressively this year.”
“Even though this was the first FOMC meeting under new leadership, Chairman Powell’s congressional testimony gave us a preview of his communication style, which is one of the ways he seemingly differs from his predecessors. Former Fed chairs would caveat a lot of statements, whereas Powell has been more direct regarding how the economic outlook will impact the Fed’s dot plots.
“Powell’s communication style is more absolute, and as a result, it looks like his comments are being priced in more quickly than his predecessors’ statements - this explains why market expectations were more open to a fourth rate hike this year. Given his tendency to deliver his message in black and white terms, we can expect more volatility if one of Powell’s definitive statements does not come to fruition. Powell noted that the March 21 meeting yielded one decision: rates. The rest, including the dot plots, only provide a range of possible outcomes.”
Bank of Singapore
“The Fed continues to plan for two more rate hikes this year, although only one more member would need to change their minds for this to become three. We still think there will be three more hikes. The one relatively hawkish part of the overall projections was raising the terminal rate (ie. where Fed Funds should settle in the long run) from 2.75 per cent to 2.9 per cent. On this basis, interest rates by the end of 2020 will be 0.5 per cent higher than terminal (or neutral) rates, so policy will start to be a drag on economic activity.”
“Our expectation is that interest rates will go up faster than the Fed expects, and that policy will be tight before the end of 2019. This opens the possibility - certainly only a possibility at this stage - of recession in 2020, especially if fiscal policy is tightening in response to the blow-out in the budget deficit.”
Thanos Bardas, head of interest rates at Neuberger Berman
It is important to keep in mind that the narrative throughout the Janet Yellen era was one of secular stagnation. When the FOMC first started sharing individual member forecasts in 2012, the mean terminal, or peak, Fed funds rate was around 4 per cent. As their view of economic potential dwindled, that figure drifted down to 2.8 per cent in December and has just inched up to 2.9 per cent. Whether this general decline can be reversed is a key question, but there are positive signs.
On a final note, yesterday's meeting is notable for pushing the real Fed funds rate into positive territory for the first time in a decade. The impact of this transition should not be underestimated and introduces new variables to the macroeconomic environment – most obviously an increased level of volatility for both equities and bonds. As the real Fed funds rate becomes normalised, we should expect more turbulence and an eventual, and intentional, slowdown in economic growth.