Rick Rieder, chief investment officer of fundamental fixed income at BlackRock and co-manager of the BlackRock Fixed Income Global Opportunities Fund, comments on the US Federal Reserve’s September policy statement
The FOMC increasingly recognises that the US economy is ready for an increase in interest rates before the end of the year. We believe the US economy will not only weather the change well, but may also benefit from a modestly higher – and more normal – rate regime.
- Marginally higher interest rates may even accelerate hiring, as more people gain confidence in forward interest income potential and decide to retire
- The US recovery is in solid shape and the economy should maintain a durable – yet modest – growth trajectory for years to come
- The Fed's upcoming monetary policy will be nothing like the historic tightening cycles of the past; instead, it will be very deliberate and gradual
The Federal Reserve’s Federal Open Market Committee (FOMC) laid out a statement that, while generally in line with prior announcements, increasingly recognises that recent labour market improvement and other signals suggest the economy is ready for an initial lift-off from current policy rates before the end of the year. That is also confirmed by Committee rate projections, as most participants expect a rate rise in 2015.
The anticipation of this nominal rate rise has been described as akin to the hype related to the Y2K computer glitch of 2000, but we think a better analogy might be the perennial predictions of the El Nino weather pattern creating climatic change and potential havoc. We have called for the Fed to move for a long time and believe the US economy will weather the change well and over time may even benefit from a modestly higher – and more normal – rate regime.
We think waiting and running the risk of missing a window of opportunity – particularly by focusing on not only the currently low levels of inflation, but also on international developments that the US economy can handle well – is misguided.
Keeping with our weather analogy, while many fear climatic havoc from El Nino, Californians are anticipating much needed rain to help mitigate their long-standing drought. Similarly, the potential for a Fed move to cause havoc in the economy or in markets has been dramatically overhyped and, in a parallel way, savers and investors have been experiencing just as harsh a drought in yield availability and should welcome a move away from emergency rate conditions.
"While many see the initial rate move as a tightening of financial conditions, we would argue it would merely be moving away from ‘emergency’ monetary policy to one of extremely-easy policy."
In fact, we have argued that marginally higher interest rates may even accelerate hiring, as more people gain confidence in forward interest income potential and decide to retire. Potential retirees will now have to wait until the October or December FOMC meetings to see if they shall begin to enjoy some small respite from their own income drought.
And with the Fed statement citing that “Recent global economic and financial developments may restrain economic activity somewhat and are likely to put further downward pressure on inflation in the near term,” investors will increasingly have to move beyond the Fed’s statutory mandates and to a potential host of exogenous factors in judging the central bank’s reaction function.
It is critical to recognise that, while many describe the initial rate move as a tightening of policy, and of financial conditions, and thus a new era of more restrictive policy, we would argue it would merely be moving away from ‘emergency’ monetary policy to one of extremely-easy policy. That is a more appropriate stance for an economy that is operating at a high level in a world of moderate global growth.
Despite a weaker than expected August payrolls report, as well as the recent financial market volatility – which clearly has weighed on consumer sentiment – we continue to think the US recovery is in solid shape. Indeed, the economy should maintain a durable – yet modest – growth trajectory for years to come, and its relative strength can be seen in areas such as the household net-worth-to-debt ratio, which today resides near previous peak levels from 1998.
In many respects we think the labour markets reflect the strength in the US economy better than some other data measures. For instance, with the unemployment rate dropping to 5.1% in August, and the Job Openings and Labor Turnover Survey (JOLTS) improving sharply in July, we have seen the US Beveridge Curve shift to its strongest point since the recession.
This is one of many representations of a labour market that has witnessed such an extraordinary degree of improvement across so many fronts that we can confidently suggest this part of the Fed’s dual mandate has been achieved. That is not to suggest there are not some pockets of slack in the labour force, or that there are no areas where technological disruptions are not causing stresses for workers, but the Fed’s blunt policy rate tools are unlikely to be of use there anyway.
The communication, while disappointing to many, and the movement of the Statement of Economic Predictions or ‘SEP’ projections – upgrading near-term growth and recognising improved labour markets, while moderating growth prospects in the longer term – nevertheless show a Fed that is going to be gradual and deliberate over the coming couple of years. In fact we would not be surprised if this Fed did not move for a while after its initial hike, and it will continue to be very sensitive to the data when considering any changes to the trajectory and level of rates going forward.
It is very clear that the Fed's monetary policy this upcoming cycle will be nothing like the historic tightening cycles of the past in terms of the consistency of movement at each meeting, or the long-term trajectory of significant rate rises.
It will be a very deliberate, gradual and potentially replete with a paused set of movements, all of which will be designed to both soothe markets and judge the influence of policy changes as they occur. We merely believe the move is long past due, and we think the Fed risks missing its window of opportunity for rate normalization if it waits for ideal conditions that realistically never seem to arrive.