Fed will underwhelm in raising interest rates…

Fed Interest rate hikes

 

The Fed is caught between a rock and a hard place. When an action is perceived as positive by one half and negative by the other half, it may be wiser to not take any action. Especially if your continuing at your current job will depend on one of two half’s.

In case any of us missed it, its election year in the US. The primaries will conclude in July, while the general election will happen in November. If the Fed raises rates before these events, it could be perceived as trying to influence the elections (positive or negative). Even worse these actions could become an election issue with both parties. Sometimes perception becomes reality.

Now why would the Fed focus on that? Yes, the Fed has to be above politics and be ‘data-driven’. Yet, consider one fact. Fed chairs are appointed by the President and confirmed by the Senate for 4 year terms and can be re-appointed for another 4 year term. This inherently makes them political persons. Yellen was appointed in Feb’2014 and will likely seek re-appointment in early 2018.

Politicians typically prefer loose monetary policy as money supply is the essential grease of the economic wheel and Fed seems to have been accommodative in the past. Recall the DotCom bubble and the Real estate bubble, which were driven by low interest rates excess’s.

So if history is an indicator, the Fed will look to have a lighter touch when it comes to raising rates. Current expectations* are for rates to rise 2-3 times this year by 25bps each time. Hikes are expected in June and another after the elections in December, with April (this month) seeing another possible hike.

We may not get that many rate hikes.

To be clear, we think the economy can support additional hikes. In our view the Fed should have tightened to around 1% by now, given nominal GDP has been at over 3.5% for the past 2 years, with unemployment being at ~5% currently and core inflation running around the 2% mark.

Don’t forget, the Fed is seeing the ECB, Japan and other pursue negative interest rates, which could reduce pressure on them for lifting rates.

Negative Interest Rates

What does all this mean for us. Look the Fed controls the short end of the curve, but the market sets the long end of the curve. So Fed rate move will have limited impact on the market, but it likely influences short-term sentiment, so adjust portfolios accordingly. Expect the Fed to have a light touch on the rate hikes this year and in turn expect interest rate sensitive sectors (e.g. Utilities, Financials, Bonds etc.) to start responding as rate expectations are adjusted downwards.

 

*https://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20160316.pdf

**Past performance is no guarantee of future results. A risk of loss is involved with investments in capital markets. Please consider investment actions in light of your goals, objectives, cash flow needs, time horizon and other lasting factors.