27 September 2018
This month marked ten years since the Lehman Brothers bankruptcy, and the U.S. Federal Reserve has brought an anniversary present. Following the Fed’s latest hike, the interest rate is higher than the inflation rate for the first time in a decade, finally preserving the purchasing power of savers.
The Federal Open Market Committee (FOMC) concluded its September monetary policy meeting on Wednesday and, as widely expected, raised the US interest rate by 0.25 per cent. The Fed funds target range is now 2 per cent to 2.25 per cent.
The Fed’s statement removed the sentence saying that the stance of monetary policy remains accommodative, possibly making the change because the interest rate is now above the inflation rate. However, it continued to state that it intends to gradually raise the interest rate - so presumably policy will become ‘tight’ next year. The statement made no mention of tax cuts or protectionism.
Projections intact despite EM volatility
Policymakers’ interest rate projections suggest one more rate rise to come in 2018 - likely at the December meeting, and wholly expected by the market.
Emerging market volatility has done nothing to deter the Fed from stating that it will continue on its rate-hiking path in 2019, as it left its projections intact and expects the interest rate to reach 3 per cent to 3.25 per cent by the end of next year (though the market is fractionally less hawkish than that). The Fed expects one more rate rise in 2021, and thereafter it will be on hold, even into 2021.
It revised up its economic projections, with gross domestic product (GDP) growth for 2018 now expected to be to 3.1 per cent, compared to a projection of 2.8 per cent in June. “The economy continues to surprise us to the upside”, Fed Chairman Jerome Powell said.
The Fed expects growth at 2.5 per cent in 2019; 2 per cent in 2020; and a return to trend growth of 1.8 per cent in 2021. It made no change to inflation and unemployment projections from those it set out in June.
Powell says financial conditions remain accommodative
Powell is a man of simpler words than his predecessors: “Our economy is strong”, and ”wages are growing”, he said at the post-meeting press conference.
He shied away from opining on trade wars, but he did say regional Fed banks had anecdotal evidence of firms experiencing disruption to supply chains, and that the central bank would prefer no such war.
Overall financial conditions remain accommodative, he said (and dropping the word ‘accommodative’ is not a signal that the Fed is reconsidering its rate increase intentions).
Remain overweight in risk assets
US monetary policy decisions for the remainder of 2018 are uninteresting. What is most interesting is the Fed’s stated intent to continue normalising rates in 2019, notwithstanding overseas grumbles about the impact of a strong US dollar, volatile emerging markets, and political uncertainty.
I have long argued that there is no good reason for saving in low risk assets when the interest rate is less than the inflation rate, so perhaps we will see some changes in risk-taking behaviour in the US from now, mainly via asset price behaviour. That is what I will be looking out for, but until then I remain overweight in risk assets.
There was no mention of ‘end-of-cycle’ in the entire press conference, and its tone was more about the strength of the US economy. Nevertheless, with a 3 per cent 10-year Treasury yield, I am happy to retain some bond duration, not least because bonds would stand to do well if there is a reverse to risk-taking behaviour. Index-linked bond exposure feels more and more important to feature in portfolios now, as any increases in inflation could knock over the investment apple cart, for both equities and bonds. With wages rising, the risk of inflation grows.
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