InvestmentsJul 20 2015

Interest rate rise is likely to be gradual

twitter-iconfacebook-iconlinkedin-iconmail-iconprint-icon
Search supported by

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.

David Absolon, investment director at Heartwood Investment Management, acknowledges the June monetary policy statement was “marginally more upbeat about the prospects for the US economy than in April, although policymakers’ forecast of interest rate expectations were slightly more dovish than expected”.

He adds: “We expect the Fed will exit its zero interest rate policy this year, although the path of rate rises will be gradual. The latest US data trends show an economy that is gathering momentum in the second half of 2015. The employment market remains strong, including a pickup in wage data.

“We are also seeing rising housing activity and stronger consumer spending. The manufacturing sector has been weighed down by a stronger US dollar, but forward-looking indicators are showing tentative signs of improvements.

“As the oil price has stabilised, moderate inflation trends are beginning to emerge, which should further support the Fed’s decision to exit emergency liquidity.”

But while most expect a rate rise, the Fed continues to emphasise the importance of data in driving any changes. In a recent speech in Oxford, vice chairman Stanley Fischer acknowledged the perils of waiting too long to make a decision.

“We are aware of the possibility that the low interest rate maintained for a prolonged period could prompt an excessive build-up in leverage or cause underwriting standards to erode as investors take on risks they cannot measure or manage appropriately in a reach for yield.

“At this point, the evidence does not indicate that such vulnerabilities pose a significant threat, but we are carefully monitoring developments in this area.”

Nyree Stewart is features editor at Investment Adviser

EXPERT VIEW

Kully Samra, managing director of Charles Schwab UK, thinks the first rise will be in September:

“The Federal Reserve has taken great pains to prepare investors for a hike in the interest rate at some point this year. It clearly doesn’t want to disrupt financial markets through its heightened transparency.

September seems to be the most likely ‘lift-off’ point. But unless inflation unexpectedly accelerates in the near term, the Fed has made it clear it plans to move slowly towards a more normal policy stance.

While this doesn’t mean there won’t be some hiccups along the way, it could mean more dampened volatility than would otherwise be the case. And history shows that the stockmarket performs substantially better during a slow tightening cycle than a fast one.”

TIMELINE: KEY MOVES BY THE FED

• June 2006 – Last interest rate rise by the US Federal Reserve from 5 per cent to 5.25 per cent

• August 2007 – As the sub-prime mortgage crisis starts to unfold, the bank announces it will “provide reserves as necessary through open market operations” and “temporary changes to its primary credit discount window facility”

• September 2007 – The central bank cuts its rate from 5.25 per cent to 4.75 per cent. The first time it had cut the rate since June 2003

• December 2007 – The Bank of Canada, the Bank of England, the European Central Bank, the Fed and the Swiss National Bank unveil measures to address elevated pressures in short-term funding markets

• March 2008 – The Fed announces further measures to ease short-term funding problems, including an expansion of its securities lending programme

• November 2008 – The US central bank agrees to buy the “direct obligations” of the government-sponsored enterprises Fannie Mae, Freddie Mac and the Federal Home Loan Banks, and the mortgage-backed securities of Fannie Mae, Freddie Mac and Ginnie Mae – known as QE1

• December 2008 – The interest rate is cut to the current low of 0-0.25 per cent

• November 2010 – The bank unveils plans to purchase a further $600bn (£390bn) of longer-term Treasury securities by the end of the second quarter of 2011 at a pace of $75bn a month – known as QE2

• September 2011 – The Fed announces Operation Twist, a maturity-extension programme and reinvestment policy

• September 2012 – The central bank increases policy accommodation by purchasing additional agency mortgage-backed securities at a pace of $40bn a month – often referred to as QE3

• June 2013 – Chairman Ben Bernanke mentions plans for the ‘tapering’ of quantitative easing (QE)

• October 2014 – The bank concludes its asset-purchasing programme