21 September 2015

In a mildly dovish statement, the US Federal Reserve (Fed) continued to delay normalising rates, citing both some inflation concerns and “global economic and financial developments” in explaining its rationale. We worry that the Committee risks missing its window of opportunity should it wait for “ideal” conditions that in reality rarely arrive.

Numerous metrics suggest that the US economy is prepared for the start of rate normalisation. The arguments implying that a moderate rate rise may cause havoc in the economy or markets are overhyped. Rate normalisation, when it eventually does come, will be very deliberate, gradual and potentially with paused 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 overdue.

Higher rates could be beneficial

The 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 that the economy is ready for an initial lift-off from current policy rates before year-end. That is also confirmed by Committee rate projections, as most participants expect a rate rise in 2015.

We have called for the Fed to move for a long time and believe that the US economy will weather the change well, and over time may even benefit from a modestly higher (and more normal) rate regime. We believe 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.

The potential for a Fed move to cause havoc in the economy or in markets has been dramatically overhyped, and savers and investors would welcome a move away from emergency rate conditions. 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 might begin to enjoy some small respite from ultra-low interest rates.

Moving from “emergency” to extremely easy

It’s critical to recognise that while many describe an initial rate move as a tightening of policy, and of financial conditions, we would argue that it would merely be moving away from “emergency” monetary policy to one of extremely easy policy. That is more appropriate 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 and the recent financial market volatility (which clearly has weighed on consumer sentiment), we continue to believe 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.

Labour market strength

The labour market perhaps best reflects the strength in the US economy, 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. Indeed, many representations of a labour market that has witnessed such an extraordinary degree of improvement across so many fronts suggest that this part of the Fed’s dual mandate has been achieved. That is not to suggest that there aren’t some pockets of slack in the labour force, or that technological disruptions aren’t causing some stresses for workers, but the Fed’s blunt policy rate tools are unlikely to be of use there anyway.

Hiking cycle like no other

The communication and movement of the central bank projections (upgrading near-term growth while moderating growth prospects longer term) show a Fed that is going to be gradual and deliberate over the coming couple of years. In fact we wouldn’t be surprised if the Fed didn’t move for a while after its initial hike, and it will continue to be very sensitive to 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 tightening cycles of the past in terms of the consistency of movement at each meeting, or the long-term trajectory of rate rises. It will be very deliberate, gradual and potentially with paused 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 overdue, and think the Fed risks missing its window of opportunity for rate normalisation if it waits for ideal conditions that realistically rarely arrive.

CARS ref: RSM-1982
This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or financial product or to adopt any investment strategy. The opinions expressed are as of 18 September 2015 and may change as subsequent conditions vary.

We have called for the Fed to move for a long time and believe that the US economy will weather the change well.