Interest rate rise is likely to be gradual

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Investing in the US - July 2015

As employment figures remain steady and economic growth improves moderately, expectations are growing that the US could in September implement its first interest rate rise since June 2006.

The federal funds rate has been at between 0-0.25 per cent since December 2008, but even if the US Federal Reserve (Fed) does start tightening its rate, it’s unlikely to be a significant rise.

James Harries, manager of the BNY Mellon Global Real Return fund, suggests that some investors “are perhaps a little overzealous” about the strength of the US recovery and how quickly and high rates are likely to be increased.

He says: “People believe US interest rates are going to go up much more than they will, but we think expectations will be lowered over time. As predictions shift from expecting a considerable rate rise to a much less steep increase, to perhaps no rise at all, we anticipate a corresponding period of US dollar weakness.”

Bryn Jones, head of fixed income research at Rathbone Unit Trust Management, suggests the Fed could be looking to raise its rate by 25 basis points in September.

But he adds: “I think the rate rise is going to be slow and protracted. The reason I think there will be an increase is because we’ve got confidence picking up, employer behaviour picking up and the leading indicators are all quite positive.

“There is a small part missing, which is the economic slack and spare capacity. For example, job openings in the US are at an all-time high, with 5.4m jobs available. Job openings are now higher than hiring levels for the first time ever.

“So the interest rate will go up because of the stronger economy, but it can only rise slowly because I don’t think wage inflation will be as great. If we start to see wage inflation kicking through quite quickly, then the Fed will get worried and move a little more quickly.”

Clare Hart, manager of the JPM US Equity Income fund, says: “We’ve got beyond the patch of weak economic data earlier this year and are returning to stronger growth, as signalled by healthy labour market data in recent months.

“Ironically, the marginal uptick in the US unemployment rate is a positive indicator, because it suggests more workers are motivated to rejoin the job market as the economy gets brighter.

“We’ve longed to see more robust GDP growth throughout this recovery, although the modest growth so far hasn’t held back the magnitude or longevity of the six-year equity bull market.”

In its June 17 meeting this year, the Federal Open Market Committee issued its economic projections, which were slightly less optimistic on real GDP growth for 2015, moving from a range of 2.3-2.7 per cent estimated in March to 1.8-2 per cent three months later. But for the next two years it predicts a slightly better range of 2.4-2.7 per cent in 2016 and 2.1-2.5 per cent in 2017.