Each new report of strong US economic growth, as well as rising but under-control inflation, seems to validate the Fed’s approach to normalising US monetary policy. But the central bank won’t put rate hikes on autopilot next year; rather, it will keep monitoring inflation and risks from trade wars, Brexit and emerging markets.
The Fed’s gradual withdrawal of accommodation was once again supported by the latest US jobs data: strong payrolls, healthy wage growth and low unemployment
Inflation moved higher in August, reaching 2.7%, but it hasn’t spiked in a way that should affect the Fed’s tightening plans
We expect a 25 bps hike at the FOMC’s next meeting, and one more after that before the end of the year – but it won’t put rate hikes on autopilot in 2019
As the Fed inches closer to the neutral rate, it will keep monitoring risks to the US economy, including trade wars, Brexit, Italian politics and contagion in emerging markets
Economic activity is booming in the US, and the Federal Reserve appears to be doing a continued good job of normalising monetary policy while keeping an eye on inflation.
Although the August CPI report was slightly below expectations, the August employment report delivered a robust set of data points. US payrolls have been strong, wage growth is healthy at 2.9% and unemployment is at 3.9%. Even the U-6 report – the broadest measure of unemployment – fell in August to an impressive 17-year low.
This convergence of economic activity clearly indicates a US economy that is rolling along. But while inflation is trending higher – reaching 2.7% in August – it is not spiking in a way that should send a warning signal to the Fed.
As a result, we expect the Federal Open Market Committee (FOMC) to announce a rate hike of 25 basis points after its 25-26 September meeting, while emphasising that continued monetary-policy normalisation is required. We anticipate one additional rate rise at the November or December meeting – for a total of four increases in 2018 – and two more in the first half of next year.
But it is important to emphasize that the Fed won’t put its rate-hike plans on autopilot. The FOMC will be pragmatic as it moves closer to the neutral rate – a rate that neither stimulates nor restrains economic growth. Estimates vary about what the right neutral rate is, but the president of the Dallas Fed, Robert Kaplan, says it is around 2.5%; other estimates place it around 3%. (The target range for the fed funds rate is currently 1.75%-2.00%.)
Regardless, as the Fed inches closer to the neutral rate, we expect it to stay immune to political pressure as it assesses the path of inflation and its risks to US economic activity. At the same time, the Fed is well aware of the risks on the horizon – including escalating trade wars, a hard Brexit, contentious politics in Italy, contagion in emerging markets and deceleration in China.
Overall, Fed policy is still accommodative while clearly not behind the curve, and the Fed appears to be raising rates at the appropriate rate to keep up with inflation. Keep in mind that the FOMC started to hike at the beginning of the current economic cycle, when we had no inflation, because it was confident that inflation would return. And the Fed was right.
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Franck Dixmier is Global Chief Investment Officer (CIO) Fixed Income and a Managing Director with Allianz Global Investors. In this capacity, he leads and oversees the development of the firm’s Fixed Income capability and investment offering. He is a member of AllianzGI’s Investment Executive Committee and International Management Group.
The recent US equity market setback seems to be little more than a wobble. The global economy is not in recession, although it is slowing down, and monetary policy is still accommodative across the board. Nevertheless, this is cold comfort to investors who have become sensitive to even smallish corrections.
Neither the US nor the global economy are close to recession: the Fed and other central banks are still accommodative, and financial conditions are still loose
Longer-term Treasury yields are not at levels that should force asset allocation changes out of equities and into bonds
Trade wars are painful, but they should not have a huge negative economic cost
Quantitative tightening and rising US rates are supporting the US dollar, but it has risen only 7% this year
Equity valuations are high, but shorter-term earnings growth is still strong
A bullish stance would be supported by US Treasury yields stabilising at current levels (around 3.15%)
A bearish view would see high-yield credit spreads start to widen from current levels