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Fed signals new policy phase, and six further rate hikes?

The Federal Reserve’s decision to raise its benchmark rate for the second time in three months, has led to speculation of further rises this year, with another four to come in 2018.

As widely expected, the Fed followed up its December rise with a further 25bps hike to 1%, with equity markets predictably reacting positively.

Still, some believe the Fed remains behind the curve.

“Despite the rate increase, the Fed maintained its emphasis on the need for accommodative policy and gradual rate increases even as the US economy has essentially achieved the Fed’s key targets for GDP growth, inflation, and unemployment,” said Ken Taubes, head of investment management, US, at Pioneer Investments.

“In fact, since their rate hike in December, US financial conditions have eased. The short end of the curve still offers negative real yields despite full employment, above trend growth, and rising inflation conditions.”

The expectation is that US policy makers will accelerate its hiking, with further moves a possibility in June and September.

While seeing the Fed’s latest rise as “fait accompli”, Bryn Jones, Rathbones’ head of fixed income, is cautious on the long-term impact of a hiking cycle.

“The Fed see two more hikes in 2017; incidentally, oft-cited Morgan Stanley see a total of six by the end of 2018, which I also believe is a possibility,” he said.  

“By this time, however, the virtuous circle of high-yield refinancing is likely to kick in, where supply outweighs demand at a time when revenues drop, and interest expense rises – the Fed then have to go on hold again, followed by emergency cuts to shore up markets; I’m monitoring this.”

Reading between the lines, Mitul Patel, head of interest rates at Henderson Global Investors, believes the Fed is ultimately overcompensating through fear of another taper tantrum, a repeat of the scenario in 2013 when Treasury yields surged.

“When central banks tighten monetary policy, it is normally accompanied by a market reaction which suggests tighter financial conditions, which should then lead to an economic response,” he explained.

 

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