Washington’s “Mighty Doves” once again vanquished the “Regional Hawks” at this week’s monetary policy fixture, with the Federal Reserve electing to keep interest rates on hold spurring a rally across equities, bonds and emerging market assets.
Fund managers say “lower for longer” remains the leitmotif for financial markets.
Henry Peabody, a bond fund manager at Eaton Vance, thinks that a rate increase in December is still likely, but argues that the Fed is “boxed in” by ultra-easy monetary policy in Europe and Japan. “The Fed wants to raise rates, but I think they’re afraid of a strong dollar now that they’re at loggerheads with the European Central Bank and the Bank of Japan,” he says.
That reflects the new median estimate of central bank officials is that the Fed funds rate will average just 1.1 per cent next year — in other words just two more increases after one later this year. That marks a reduction from the 1.6 per cent median Fed funds forecast made at the time of the June monetary policy meeting. The median forecast for 2018 was pruned from 2.4 per cent to 1.9 per cent.
Moreover, Fed fund futures only indicate a 61 per cent chance of a rate rise in December, underscoring the underwhelming nature of the economic recovery, and how sceptical many investors are that the Fed will imperil it by tightening monetary policy too quickly.
The Fed said this week that it expects only “gradual increases” to its benchmark interest rate, however it is becoming clear this is not a gradual monetary tightening cycle but a glacial one.
Indeed the current two-year Treasury note yield at 0.77 per cent was trading above 0.90 per cent ahead of the Fed’s December 2015 meeting when it last tightened policy.
“Given that at the start of 2016 the broad view was that the Fed would hike four times this year only for the reality to turn to be one move (at best), experience says there is a good chance that even these modest expectations could be scaled back further,” says Simon Derrick, strategist at BNY Mellon.
Investors have written off the chances of the US central bank tightening monetary policy at its November meeting because of the looming presidential election, but some investors and economists had expected a “hawkish hold” this week — keeping interest rates steady but releasing a more upbeat statement with an even firmer hint of an increase in December.
The dovish tenor, therefore represented a mild surprise for markets.
And although dissent infuses the Federal Open Market Committee — with three vote-setters in favour of a September rise — the longer-term dovishness for policy was supporting long term bond prices around the world on Thursday.
Following a rally in US Treasury prices late on Wednesday, European bond prices were firmer on Thursday as equities also rose. Emerging market currencies were also bolstered as the dollar came under pressure from a lower trajectory for future interest rate policy.
Coupled with the Bank of Japan’s overhaul of its monetary stimulus package — shifting to a “yield curve control” policy where it will aim to keep the 10-year Japanese government bond yield around zero — the Fed’s punting of rate increases into the long grass is seen supporting asset prices for now.
The US economy at a glance
The FT’s one-stop overview of key US economic data and trends, including GDP, inflation, unemployment, consumer indicators, and the outlook for US interest rates,
Explore the dashboard
However, some warn that market volatility beckons.
“The US rate debate is now kicked into December when consensus is for a first Fed hike in a year,’’ says Lee Wild, head of equity strategy at Interactive Investor. ‘’But rate-setters also cut growth forecasts for the US economy both in 2016 and longer term, so nothing is certain. Prepare for another round of speculation in under three months’ time.’’
But many investors and analysts remain unconvinced that rates will rise even this year. Kevin Giddis, head of fixed income at Raymond James, zeroed in on the Fed stating that the “near-term risks to economic outlook appear roughly balanced” as evidence that officials are not on autopilot towards a December rate increase.
“That leaves the Fed continuing to look for conditions in which to raise rates,” he wrote in a note to clients. “So for all of the hype, hope and fear, the Fed has once again merely kicked the can down the road one more time. Not that it wasn’t the right decision, it just prolongs the inevitable.”