As the US Federal Reserve raises its benchmark interest rate by 0.25% for only the third time in ten years, views come into the IFA Magazine office from the City.
David Page, Senior Economist at AXA Investment Managers (AXA IM), comments:
- FOMC hikes rates as expected by 0.25% to 0.75-1.00%. One member dissents.
- Accompanying statement shifts tone on inflation to around target from likely-to-rise-to-target.
- Federal Reserve’s (Fed) economic projections mostly unchanged, including its outlook for FFR.
- Yellen said Fed discussed balance sheet, but came to no decisions.
- Markets had feared a more hawkish meeting, reacts dovishly.
- We maintain our outlook for three hikes (in total) in 2017 and four in 2018.
“The FOMC meeting concluded today with the Fed raising the Fed Funds Rate (FFR) by 0.25% to 0.75-1.00%. This event had become widely expected following President Dudley’s assessment that the case for a rise had become “more compelling” just over two weeks ago. That said, Neel Kashkari dissented at this meeting preferring to leave policy unchanged. Market attention was focused on the additional information presented at this meeting, including the Fed’s accompanying statement, March’s Summary Economic Projections (SEP) and Fed Chair Yellen’s press conference.
“The Fed adjusted the language of its statement. While on the real economy this was limited to noting that “investment appears to have firmed somewhat” (from “remained soft”). There was a more noteworthy shift in its description of inflation. The Fed stated that inflation was “moving close to the Committee’s 2% longer-run objective; excluding energy and food prices, inflation was little changed …”. It then described inflation “stabilising” (from “rise to”) around 2%; it removed the reference of “the current shortfall of inflation” and added it would monitor developments relative to its “symmetric” inflation goal. Yellen said that this insertion “seemed appropriate” after the sustained shortfall in inflation these past years.
“The Fed also updated its SEPs, although there was in the event little change here. The GDP growth forecast was revised to 2.1% from 2.0% for 2018. ‘Core’ PCE inflation was edged higher to 1.9% in 2017 from 1.8%. Longer-run estimates of GDP, unemployment, inflation and FFR rate were left unchanged. The Fed also updated its ‘dot’ projections of future anticipated FFR. The median estimate for the FFR in 2019 inched higher to 3.0% from 2.9%. This belied more of a shift in the main group of Fed participants, with nine members now expecting two more hikes this year (from six); and nine now expecting three or four hikes next year (from five).
“Fed Yellen’s press conference also delivered few surprises. She described the hike as reflecting “continued progress” to Fed goals, not a reassessment of the outlook. She conceded the economic projections were very little changed and the median outlook for FFR was “essentially unchanged”. She stated that the outlook for policy was for gradual increases (qualifying: three hikes as “certainly gradual”, but one hike more or less still gradual). She added that policy was not set in stone, but data dependent. Given this steady-as-she-goes update from the Fed, Yellen was asked what had persuaded the FOMC to tighten policy? Yellen added little here merely referring to a faster pace of labour market activity than seemed consistent with expectations for participation.
“Finally, Yellen gave no formal update on balance sheet policy, as we expected. She acknowledged that the FOMC had discussed balance sheet reinvestment plans, but said no decisions had been reached, although she added that the process of reducing the balance sheet would be gradual and predictable adding it was easier to use FFR as the key active tool. We expect a more formal update to guidelines over the coming meetings, possibly in June.
“With little further adjustment to any of the Fed’s outlook and no communication of a more hawkish trend emerging, markets, which had feared a more abrupt change, reacted. 2-year yields (whose positioning had appeared very short) saw yields fall back by 9bps to 1.30%, but 10-year yields also fell back by 7bps to 2.50%. The dollar retraced and the S&P index rose by 0.5%.
“We maintain our forecast for three hikes in 2017 (two more) and four in 2018 in the light of today’s releases. We suggest that momentum in the economy is likely to prove sufficient to see the Fed tighten policy again in June, although we do note the risk of another seasonal wild card in the Q1 GDP data. We also note that we expect the Fed to have to raise its growth (and rate) forecasts further if the new administration passes new tax laws that lead to some short term stimulus. However, we would only expect that to impact forecasts later in the year.
Andrea Iannelli, Investment Director at Fidelity International, comments:
“It’s a dovish hike by the Fed, which delivered the expected increase in Fed Funds by 25bp, but with no change to the macro forecasts or to the ’dot plot’. This will come as a disappointment for anyone who was expecting them to signal three further hikes this year or any indication of balance sheet tapering.
“The Fed is in no rush to speed up the pace of tightening and will take it slowly from here. Two more hikes are the base case for 2017 unless there’s any major change in the macro picture, and then they will see what next year brings, with the FOMC that will look very different by then.
“With no big change today, and a gentle path ahead for Fed Funds, the short term outlook remains bullish for risky assets, including credit, and for US Treasuries, particularly given the very skewed positioning in the latter. The USD, on the other hand, is likely to lose some steam as the focus shifts to the fiscal side and to other central banks.
“The longer term picture, on the other hand remains heavily dependent on the fiscal stance that the new US administration decides to adopt, although it may be difficult to pass any meaningful stimulus measure before next year.”
Helal Miah, Investment Research Analyst at The Share Centre, explains what this latest rate rise means for investors:
“The US Federal Reserve has raised the interest rate to the target range of 0.75% to 1.00% and it came as no surprise at all since the financial markets had priced in a 95% chance of this happening. The market reaction thus far has been muted given such expectations.
“This rate rise has largely come about since the recent economic data out of the US has been very encouraging as the US economy attempts to lead the world out of a slow growth environment. We have seen very good unemployment data with solid job creation for a good number of quarters, while the unemployment rate sticks below the 5% level. Just as important in the Fed’s decision is the rate of US inflation which earlier today showed that price rises over the year was at 2.7%, which was well ahead of their 2% target with a likelihood of rising further as the past falls in commodity prices falls out of the calculation. There is therefore the hope that we could begin to see more wage inflation which will natural push up general inflation in the economy further.
“Our view is that this rate rise was warranted given the economic backdrop and the market reaction should not be adverse. However, the focus for the market is the future path of interest rate rises. Indications from the Fed’s dot plot suggests that we will have two more rate rises this year, although the probability of a third rate rise has increased. The dot plot also suggests that during 2018 we should see a further three rate hikes. The market however, seems to think that we will see fewer rate rises in 2017 and 2018, as a consequence we have seen the US dollar fall against other major currencies such as the pound, which is up 1%. Meanwhile, the equity markets have reacted positively too, up by roughly 0.5% immediately after the release.
“Key comments in the statement include the phrase that the risk to inflation is “symmetric”, with current core inflation hovering around 2%, but it is clear that the Fed is looking to guard against inflation should it begin to pick up steam. The Fed kept up its upbeat view of the economy and it growth prospects with unemployment rates likely to stay at current low levels.”
What does this mean for UK investors?
“This rate rise came as no surprise and there will be further rate rises this year taking the rate to 1.375% by year end and another 0.75% higher at the end of 2018. However, the market still believes that the pace will be slower. It therefore has no issues and has reacted very well.
“Investors should view upcoming rate rises as normalisation since we have been through exceptionally low interest rates since 2008. We would suggest that investors should not fear the rises since it does signal that the US economy is growing and expected to grow further. Moreover, given that it still is the world’s dominant economy; it should have a positive spill over effect to the rest of the world.
“These rate rises will still be gradual and the Fed will be more than happy to halt the pace should the data show any signs of weakness. The UK is not expected to raise rates for at least a year. We therefore believe that the equity market still represent the asset class of choice offering capital growth and superior income levels.”
Lee Ferridge, head of multi-asset strategy for North America at State Street Global Markets, and Antoine Lesné, EMEA head of ETF strategy at SPDR ETFs, part of State Street Global Advisors, offer their views:
Lee Ferridge, head of multi-asset strategy for North America at State Street Global Markets commented: “This was the widely expected outcome from today’s meeting, with the FOMC sanctioning its second rate hike in three months, but leaving its guidance for rates over the remainder of 2017 unchanged. Improving real economic data, continued strong labour market gains and a rise in headline inflation set the stage for the FOMC to deliver the first of three projected 2017 tightenings. Attention will now most likely shift to the June 14 meeting when many expect a further increase in rates. However, with the much talked about Trump fiscal stimulus still some way away from fruition, the Federal Reserve (Fed) will wish to see continued economic strength and, perhaps, signs of a pick-up in wages before committing to a June move. We expect little market reaction to today’s decision given it was widely priced into markets. It will take further positive economic news to continue the push higher in US bond yields and US dollar.”
Antoine Lesné, EMEA head of ETF strategy at SPDR ETFs, part of State Street Global Advisors commented: “As widely expected the FOMC announced its first rate hike of 25 bps in 2017. This is only the third hike since the global financial crisis pushing the target range of Fed fund rates to 0.75-1.0 percent. The FOMC acknowledged further improvement in labour markets, business investment trends and consumer spending as well as sentiment generally rising. Meanwhile core inflation is getting closer to the Fed’s goal. Nevertheless uncertainty surrounding fiscal policy still poses some near term risks. More data will need to be gathered to envisage a more hawkish path keeping potential further rate increases to two in 2017. This could lead to bear steepening in the front end of the curve (two to five year) with two-year bond yields rising a bit less than five-year.”
Anthony Doyle, Fixed Interest Investment Director at M&G Investments:
“A concerted effort by Fed speakers to prepare the market for today’s 25 basis point rate hike worked, with markets fully anticipating the decision. The FOMC determined that the US economy needs higher interest rates following the continued tightening of the labour market and building inflationary pressures. The surge in headline inflation to a five-year high of 2.7% in February is a concern for the Fed, who will be keen to ensure that inflation expectations remain well-anchored. With Chair Yellen stating in a recent speech that “the process of scaling back accommodation likely will not be as slow as it was during the past couple of years”, we anticipate at least two more rate hikes, with a good chance of three by the end of the year dependent upon the extent of fiscal stimulus that is announced by the U.S. government.
“In addition to the underlying strength of the U.S. economy, the global economic backdrop remains supportive. Both China and Europe are growing nicely, suggesting that global growth is set to accelerate in 2017 after slowing to 3.0% in 2016. We expect global corporate default rates to remain low and therefore a favourable environment for risk assets like investment grade and high yield corporate bonds. In addition, interest rates are likely to remain on an easy setting in the UK, Europe, and Japan causing a widening in interest rate differentials to the U.S., suggesting a further strengthening of the U.S. dollar versus the majors. The main downside risks to the global economy appear to be political developments in Europe and the U.K., a major change in U.S. trade policy, or a delay in the implementation of U.S. tax reform and fiscal stimulus.”
deVere Group’s founder and CEO, Nigel Green, says: “This rate rise by the world’s defacto central bank confirms that we’re in a new era of higher inflation and higher interest rates. Investors will now need to position themselves accordingly.
“Rates are beginning to normalize. Whilst it may take a couple of years or so to get there, when they do the global economy will look very different to how it does today.
“With this shifting landscape, investors now need to ask themselves three key questions.”
“First, is my portfolio truly diversified? Having a well-diversified portfolio is one of the fundamentals of successful investing, but alarmingly, and for a myriad of reasons, many investors are simply not adequately diversified. This puts them at risk and means they are likely to miss out on opportunities.
“Being truly diversified across asset classes, sectors and geographical areas, and not trying to be too smart with sector or regional bets, is perhaps more important than ever. The traditional interrelationship between sectors and regions has diminished since President Trump took office. A lot will be riding on which way the greenback heads and, crucially, which policies are green-lit by Congress.
“Second, am I prepared for dollar swings? In the short term, higher Fed rates will attract overseas capital into the U.S., especially to those sectors, such as energy and financials, that will most likely benefit from Trump’s policies. On the flip side, emerging markets will become less attractive because a strong dollar makes interest and repayment more costly in local currency.
“However, the strength of the dollar might weaken again in the coming months. The markets are pricing in three hikes in 2017 – I think it will be two, which would result in a fall back of the greenback later in the year.
“And third, am I prepared for inflation? The American economy might not have a serious issue with inflation now, but we can be almost sure inflation is going to creep up on us.
“Investors need to keep some powder dry in preparation for this time as their dollar-buying power will be hit when it finally arrives.”
“Investors who answer these questions honestly and then take affirmative action will find that they do not need to accept lower returns in this new era of higher rates and inflation.”
Tom Stevenson, investment director for personal investing at Fidelity International, comments:
“With the US economy continuing to flex its muscles and with inflation on the rise, all eyes have been on the US Federal Reserve today and you didn’t need to be a fortune teller to predict today’s decision to hike rates from a 0.5-0.75% range to 0.75-1.0%. The Fed’s rate-setters have been providing broad hints for some time that they were minded to tighten policy today.
“So far markets have reacted positively to the decision which suggested the Fed remains cautious about normalising monetary policy. The key question is how investors will react over the longer term to the latest ‘dot plots’, the chart which indicates the rate predictions of the rate-setters on the open markets committee. The latest charts suggest we could see a modest acceleration in the tightening of rates, but not enough to unsettle investors.
“Rising interest rates tend to be bad news for bond prices. We have already seen yields rise on the assumption that rates would be hiked today and if rates and yields continue to rise, we would expect bond prices to continue to be under pressure. However, the Fed is clearly erring on the side of caution which provides some support to fixed income investors.
“Rising US interest rates have also traditionally been viewed as bad news for emerging markets as higher US interest rates mean a strengthening of the dollar which depresses emerging market currencies, making it harder for these countries to service their debts which are typically denominated in USD. However, the start of a US interest rate tightening cycle can actually be good for emerging markets to the extent that it reflects a strengthening global economy.
“Ultimately, rising rates in the US and a higher US dollar can help foster an equity friendly environment. That’s because investors tend to focus in the early phase of a tightening cycle on the reason for rates rising rather than on the ultimate impact of higher rates on economic activity. With this in mind, investors may want to consider a global equity fund.
“Here are two we particularly like:
“Rathbone Global Opportunities Fund. The fund has a significant US weighting and focuses on technology stocks like Amazon and Facebook and on consumer names like Visa. The geographical and sector biases of the fund make it particularly suitable for a long-term buy and hold investor. The manager, James Thomson, has a focus on finding companies with a sustainable growth story and is prepared to pay up for quality. He likes to find under-the-radar or out-of-favour companies.
“Fidelity Global Dividend Fund. For those who want or prefer an income fund then Dan Roberts’ fund may be a suitable choice. Dan scours the globe for attractive income streams but never compromises on quality – he is intimately concerned about preserving client capital. To that end, he places heavy emphasis on scrutinising financial statements to ensure that companies can afford to pay the dividends which they are offering.”
Nick Dixon, Investment Director at Aegon UK commenting on US interest rates said: “Strong economic and job data from the US has only increased calls on Yellen to hike interest rates, so it is no surprise to see the rise today. Investors will now keep a close eye on the forward look for indications on when the next UK rate rises are scheduled, and today’s US increase adds momentum to the case for this. Historically the Bank of England follows its US counterpart, but with Article 50 about to be triggered, it may well be that the UK will have to wait until Q2 or Q3 for any movement.”