I mentioned last week that the Fed raised the federal funds rate to 0.50%-0.75% which was the first rate hike in 2016 and only the second increase during this economic cycle, the last being in December 2015. At the start of 2016 APCM was looking for two rate hikes which did not play out as the Fed held rates stubbornly low. However, we were more correct than the consensus which was for four rate hikes. We thought the anticipated four rate hikes was aggressive in the face a stream of literature and speeches from the Fed speaking about the risks to the economy of their rising rates too fast with low inflation and employment not at the optimal levels.
Fast forward to today, the consensus is for three rate hikes in 2017. APCM is currently looking for the Fed to raise twice in 2017. We acknowledge the fact that inflation is grinding towards the Fed informal target of 2% and employment is very close to full employment. We think monetary policy will remain accommodative as the balance sheet of the Fed ($4 Trillion) will remain in place.
Why does APCM have a below consensus view on rate hikes?
The consensus has built in vast fiscal stimulus bump in 2017 and we think there is still some uncertainty surrounding the quality and amount of any fiscal stimulus. A combination of tax cuts for individuals and businesses has not been defined leaving the lasting direct impact on economy ambiguous at best. Another infrastructure spending package would have secondary effects on the economy and is not a new phenomenon. The final form and how quickly these get through congress is still yet to be determined.
I recently finished up reading former Fed Chairman Ben Bernanke’s book “The Courage to Act” and was surprised by the coordination as to how the global central banks reacted to the financial crisis. Even though each central bank has its own mandates it is still realistic to believe the Fed does not want to get too out of sync with the rest of the world.
The risk to the economy of rising rates to quickly is greater than leaving rates low. Current Chairwomen Janet Yellen’s remarked in a speech in 2012 that there are positive benefits to running “a high pressure economy”. We admit that the remarks were more appropriate in 2012 where the environment was a low inflation-low rate-low growth when the remarks were made compared to today’s rising inflation-higher rates- higher potential growth the risk but we keep them in mind for context.
William Lierman, CFA®
CIO, Fixed Income