Fed hikes rate as markets watch for further signals
US Federal Reserve chair Jerome Powell's announcement of a 25-basis point interest rate rise overnight was largely anticipated, though the pace and number of further shifts remain uncertain.
US Federal Reserve chair Jerome Powell's announcement of a 25-basis point interest rate rise overnight was largely anticipated, though the pace and number of further shifts remain uncertain.
The decision from Powell, in his first meeting as chair of the Federal Open Market Committee (FOMC), lifts the official interest rate to 1.5 per cent. While this was already largely priced into equity markets, there are uncertainties.
According to Morningstar's head of equities research, Peter Warnes, investors will be more closely watching the FOMC's Dot Plot, especially given the "relatively robust economic data since the December meeting".
"The Dot Plot now seems to have more importance than the convoluted narrative accompanying the FOMC decision," Warnes says.
He believes the continuing tightening of the US labour market means it is the "changing perceptions on the speed or otherwise of rate hikes that will have a meaningful influence on the path of equity markets over 2018".
This latest Dot Plot indicates there will be at least another three hikes over the year, in addition to last night's increase.
Some commentators--including two of those quote below--suggest four possible rate increases would only take the official rate a total of 1 per cent higher to 2.5 per cent--and Warnes agrees.
"But a 67 per cent increase in the rate will percolate through the entire interest rate structure and have more than a slight impact in this record leveraged world," Warnes says.
In the UK, the Bank of England will announce its interest rate decision later today, followed by the European Central Bank in early May.
Investors shouldn't be rattled
Investors should tread cautiously in avoiding the temptation to make significant portfolio changes in response to the return of volatility, which Warnes believes is very necessary for global markets.
"Don't be rattled by volatility--use it to your advantage. It is the abrupt or unexpected change in financial markets, particularly those producing sharp downward movements, that the astute investor waits for to ambush indiscriminate sellers," Warnes says.
Nick Peters, multi asset portfolio manager, Fidelity International
"The dots have moved higher across the board. Don’t be fooled by the median remaining at ‘three hikes for 2018’. In essence, the FOMC is now perfectly split between three and four hikes, and all but gone is the tail of those who thought there were downside risks to that.
"Four hikes is a very real possibility. But 2018 may not be the most important dot.
“According to the dot plot, 2019 will see another hike. 2020 will see an additional hike or more, which implies that Fed policy will have to turn meaningfully restrictive at that point. And the Fed is willing to wager that rates will need to be structurally higher than previously thought, in that its ‘long-run dot’ moved slightly higher for essentially the first time after years of moving down. Powell suggested that the Fed will tread carefully, but is open to the possibility that this could extend further.
“These later dots are most important for long-run funding costs, and in turn growth and investors.
“Despite this potentially interesting move upwards in the ‘dots’, new Chairman Jerome Powell was not in the mood to rock the boat at the press conference.
“Today’s key takeaway is simply that a more forceful turn towards hawkishness - which had been hinted at in a couple of recent Fed speeches by Powell and others - did not materialise. Yes, the dots hinted at a more hawkish path. But Powell wants us to know that the Fed are still in no rush to get ahead of the curve.
“We continue to focus on other questions. Will higher US budget deficits combined with Fed ‘quantitative tightening’ put painful upward pressure on borrowing costs? Will China slow as its policy stimulus is increasingly removed? These will drive the economic outlook, and in turn Fed policy; it won’t be the other way around.”
Gerard Fitzpatrick, EMEA CIO, Russell Investments
“Jerome Powell has not stumbled at the first hurdle, but there are bigger fences ahead. The Fed is willing to allow inflation to accelerate up to, and even slightly overshoot, its 2 per cent target, while then anticipates readiness to tighten even more than anticipated next year, thus achieving their optimal target. This is all consistent with an improved outlook for employment and a confidence to manage inflation effectively.
“This confident and positive outlook with three, rather than four, rate hikes stated for 2018 was initially welcomed by equity markets, who feared “hiking upheaval”. However, against that, market bears shortly afterwards sold the equity market, with fear focusing on risks associated with accelerated inflation over coming months and uncertainty that the brakes could be applied on time.
"Risks are still skewed a bit more for another treasury tantrum ahead, but so long as treasury yields only modestly increase, they will protect the equity market for now," Fitzpatrick says.
Hari Balkrishna, T. Rowe Price
"Last year we saw lower than expected inflation…and while inflation has picked up some, I'd argue driven largely by the uptick in oil prices, but it's still stayed pretty subdued in this cycle.
"Here we were [as commentators] debating about whether inflation is going to be 1 per cent, 1.5 per cent or 2 per cent, we have a structural outlook for inflation that it stays quite subdued. Cyclically, we might have a period where inflation might pick up some, but our view is not that it's going to break out into a new range of 3, 4 or 5 per cent."
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Glenn Freeman is a senior editor at Morningstar.
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