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US Central Bank Tightens, Most Others Stand Still - Wealth Managers' Reactions

Tom Burroughes, Group Editor , 15 December 2017


The Fed, meeting last week to discuss rates - along with a number of its international peers - chose to raise borrowing costs, while its counterparts stood still, for now. Here are some reactions from wealth and asset managers.

Unsurprisingly it seems, the US Federal Reserve decided to raise interest rates by 0.25 per cent last week, following its Federal Open Market Committee meeting, marking the third such hike this year. This lifts the benchmark federal funds rate to a range between 1.25 per cent and 1.5 per cent. The central bank expects three quarter-point rate rises in 2018, and two such rises each in 2019 and 2020. In Hong Kong, the HKMA, the de-facto central bank of the jurisdiction, also put up rates – the Hong Kong dollar is pegged to the US dollar. European Central Bank, Bank of England, Swiss National Bank and Norges Bank all left rates unchanged last week. 

The issue of low rates since 2008, and the prospect for some sort of rate “normalization”, has often been the silent “beast in the living room” for wealth managers around the world. The hunt for yield has driven activity such as the much-discussed shift towards private capital markets (private debt and equity, private real estate, etc.). The erosion of long-term savings by low, or even negative, real rates has arguably even hampered the kind of investment needed to fuel long-term productivity growth and therefore, real incomes over time. So a return to more normal rates is likely to be a welcome development. But as ever with economics, the devil is in the detail, and particularly, the timing of any change. And a new Fed chair, Jerome Powell, is due to take over from Janet Yellen next year. (He has been seen as a continuity candidate rather than a bold innovator.)

Here are some wealth management firm’s reactions.

Michael Lai, Investment Director, GAM (giving a China-themed reaction)
While US interest rates have started to rise since 2015, the Fed has not been in a hurry to hike interest rates because inflation has been low, due to structural forces, despite the healthy economy. It has also announced plans to shrink its balance sheet though adopting a gradual approach that will extend until end-2025.

China has also been on a tightening monetary policy bias. Interbank rates have firmed and the overall yield curve has shifted upwards as government policy from spring 2017 focused on containing the explosive growth in the shadow banking industry. The low M2 growth in recent months reflects the significant decline in banks’ lending to the non-banking financial institutions. Increased commentary surrounding China’s potential Minsky moment - a sudden collapse of asset prices after a long period of growth, sparked by debt or currency pressures - has focused government action around the need to de-lever the financial sector. We believe that China will continue to tighten via the orthodox channels (raising rates), especially in light of the fact that officials have achieved their growth targets for this year. In addition, this year’s 19th party congress yielded a pronouncement to move away from quantitative policy targets, in favour of a focus on long-term objectives. 

Meanwhile, the prospect of continuity in Fed policy under the new chair is positive for China. Powell’s appointment is not a controversial choice and he is seen as likely to adopt Yellen’s policies which are viewed to be on the dovish side, since we have not seen any pre-emptive hikes in recent years. Despite low unemployment and economic growth stronger than trend the Fed has proved reluctant to raise rates aggressively because inflationary pressures are absent. Consensus expectations suggest that the recent hike will be followed by three more in 2018. 

​Assuming further incremental rises of 25 bps, we can expect US interest rates to reach 2.25 per cent next year, which is still considered neutral although real US interest rates should finally turn positive, rising from -0.5 per cent to +0.7 per cent. Nevertheless, US banks are expected to continue lending because their balance sheets have improved significantly and corporate America is witnessing a revival in capex. 

Thanos Bardas, portfolio manager, head of interest rates and sovereigns at Neuberger Berman
The 25 basis point move was widely expected, with the Fed citing accelerating economic growth and a strengthening labour market as reasons for maintaining its steady tightening course. Its growth forecast increased by 0.7 per cent cumulatively over the next three years, while its expectation for unemployment dropped two tenths of a percent to 3.9 per cent, both figures incorporating potential fiscal stimulus. Yellen expressed confidence that inflation, although likely a bit below the 2 per cent target due to transitory issues, should gravitate toward that level over the next year. The Fed plans to continue to gradually reduce its $4.5 trillion balance sheet.

With the current rate increase, Yellen will leave the Fed on January 31, 2018, (after one more meeting) about halfway through the normalisation process. Since December 2015, short rates have risen from around zero to the current range of 1.25 per cent-1.50 per cent and, according to FOMC members’ ‘dot plot’ expectations, should ultimately reach around 2.75 per cent.

Thus far, normalisation has been a thing of beauty. It’s been soft in its impact on the market and accompanied by low volatility across asset classes, whether rates, equities or credit, as well as benign for the economy. Now, with three quarters of 3% plus US growth under its belt, conditions appear to be returning to a more normal, pre-crisis type expansion, while Europe and much of the emerging world are operating on all cylinders.

Lee Ferridge, head of multi-asset strategy for North America at State Street Global Markets
As widely expected the Federal Reserve (Fed) raised rates by 25bps at its December gathering, the third such hike in 2017. Given the market was pricing in a 98 percent probability of such a move, it came as little surprise meaning little market reaction is expected. Also in line with expectations, the FOMC left its dot plot for rates in 2018 and 2019 unchanged.

While, following its November gathering the Fed described inflation (excluding food and energy) as `soft’, continued strong real economic data left little doubt over a December tightening. The Fed’s expectation that wage inflation must soon materialise given extremely low unemployment rate also means it remains confident of delivering further hikes in 2018. Indeed, we have seen some pick-up in inflation expectations of late and our PriceStats1 series shows online prices gathering momentum once again in recent weeks.

Joseph Davis, PhD, global chief economist and head of the Vanguard Investment Strategy Group
With a 0.25 per cent rate hike, despite continued low inflation, the Fed is focusing on the strength of the labour market, signalling they are prepared to press on with rate increases and the path towards normalization in 2018. However, markets have not yet priced in the Fed’s expected path of three rate hikes next year which could trigger short-term volatility, a concern highlighted in Vanguard’s 2018 Economic and Market Outlook.

Rick Rieder, BlackRock’s chief investment officer of global fixed income
The announcement today of a further quarter-point policy rate hike by the Federal Reserve’s Federal Open Market Committee was not surprising, and indeed it was widely expected. That is largely because it has become increasingly clear over the past year that what is commonly thought of as the Fed’s dual mandate has effectively either been achieved (in the case of labour markets), or is likely to be shortly met (in the case of price stability of near 2 per cent).

In fact, after another robust month of job growth in November, during which 228,000 jobs were gained, combined with a 4.1 per cent unemployment rate, the US economy continues to deliver what many would call `full employment’. Indeed, as the economy continues to drive impressive job creation, there are even growing challenges presented to businesses, whereby a scarcity of available qualified labour is cited as one of the greatest problems for corporations today. This is why we believe the pace of job growth may well slow in the year ahead, as this level of growth is likely not sustainable for much longer, due to the lack of an amply qualified labour pool now in certain sectors of the economy.

From the standpoint of inflation, while it has clearly been slower to recover this cycle, there is ample evidence, including in this morning’s data that suggests that inflation is heading higher, which should soon allow the central bank to claim victory over that policy objective too. Prices are firming at both the producer level, as we saw yesterday, and at the level of the consumer, as today’s 0.4 per cent month-over-month gain, and 2.2 per cent year-over-year increase in the Consumer Price Index suggests, although Core measures were a bit weaker than consensus on apparel and shelter price weakness.

Guy de Blonay, fund manager, financial equities at Jupiter Asset Management 
The global financial sector will operate in a largely benign economic environment in 2018, but much depends on the US Federal Reserve maintaining its ‘softly, softly’ approach to quantitative tightening and interest rate rises. Innovation in financial technology will remain a key driver for the sector, bringing with it disruption but also enormous opportunity. The banking sector is a clear example of a beneficiary of financial technology as it brings down costs, boosts customer satisfaction and lifts customer retention.

A synchronised acceleration in global growth is supportive for equities, and obviously very good for financial companies. A spike in inflation could derail the slow and steady approach to raising interest rates, but there is scant evidence to suggest this may happen. The year ahead is likely to see the start of a shake-out of so-called zombie companies, which have only survived for so long because of the access they have had to cheap debt.

Yann Quelenn, Swissquote
It was as predictable as the sunrise: the US Federal Reserve increased the prime rate yesterday to 1.25-1.50 per cent. This was the third hike of 2017, and three more are generally predicted for 2018 – but we doubt next year will see a triplet of raises. The Fed is promising rate hikes to bolster the US dollar. Stronger inflation is needed to kill excess debt without bursting bubbles – and there are bubbles now in almost every US asset class. We believe inflation is higher than what the Fed says: 3 per cent versus 2 per cent. Otherwise, the US economy is strong. Unemployment rate should drop below 4 per cent in 2018, and the Fed forecasts GDP growth of 2.1 per cent. We remain bullish on the Eurodollar, although the dollar might still enjoy a Christmas Rally, in light of the Fed’s self-satisfied 2017 review.


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