US monetary policy throughout 2018 has been straightforward, with rates increasing 0.25 per cent per quarter.
Policy has been well signalled and the US Federal Reserve has been clear about the motivation for such a policy.
As 2018 ends, speculation turns to 2019.
There are a number of factors that mean a divergence of views regarding monetary policy for 2019.
Firstly the current levels - after each rate increase, by definition the level of rates is getting closer to what is perceived to be the “neutral rate” for the economy. This rate is estimated to be around 2.75 per cent to 3 per cent, so the closer official rates get to it the speculation will rise that the end of the cycle must be close.
There is also some speculation about rate cuts, partly because the US yield curve has now inverted slightly.Secondly, the outlook for economic growth in the US in 2019 is not quite as rosy as it was in 2018 as the immediate effects of tax cuts fade.
Lastly, the rest of the global economy is not quite as buoyant as it was 12 months ago and stresses have been evident in a number of emerging market economies, in particular and importantly in China.
In 2018, the US Federal Reserve remained resolute that global factors would not affect US policy, but 2019 may be different as US economic growth becomes less dominant in its thinking.
So, how much more have interest rates got to rise in the US?
Given all the factors above, four moves of 0.25 per cent appear to be the maximum we should expect. The minimum on current guidance should be two moves of 0.25 per cent, assuming rates are increased in December 2018 as expected.
This would take the upper bound of the Federal Funds Rate to 3 per cent, the so called “neutral” rate.
We would err on the side of caution (i.e. two rate increases) given that, in this economic cycle, interest rates have never risen as fast as one might expect, mainly because inflation has been so low throughout the recovery.
This is the one factor that could take the number of rate increases higher as the US Federal Reserve has a twin mandate of both economic growth and inflation.
There is also some speculation about rate cuts, partly because the US yield curve has now inverted slightly.
We don’t think that this is very probable, although it is obviously always a policy option in the event of a crisis. It is more likely that China will need to ease policy in some way in 2019.
Monetary policy divergence, therefore, is likely to still be a feature of 2019 with rates in the US tending to rise and interest rates in the other parts of the globe either unchanged or lowered.
In the eurozone our expectation is that the European Central Bank will look to escape negative interest rates as soon as it can, but first an orderly exit from asset purchases (quantitative easing) has to occur.
Their own guidance suggests that any rate increase is only likely in the second half of 2019. On a much longer term horizon, policy divergence can continue and should be expected.
It has been only synchronised over the last 10 years, post-financial crisis.
As the global nature of the financial system meant that very few parts of the world were untouched, the policy easing thereafter required co-ordination.
In the recovery, however, the different structural nature of each region has led to varying economic performance.
It should come as no surprise that as rates rise the pace will differ.
Sandra Holdsworth is head of rates at Kames Capital
