Rick Rieder, Chief Investment Officer of Global Fixed Income, BlackRock Asset Management
While yesterday’s Federal Reserve Federal Open Market Committee (FOMC) announcement may be overshadowed somewhat by the policy adjustments emanating from the Bank of Japan (BoJ) yesterday (more on this later), we nevertheless think the Fed’s statement and press conference were meaningful in a number of ways. First, they clearly indicated that the central bank continues down a deliberate path on policy moves and maintains each FOMC meeting as a potentially “live” event regarding potential rate change. That message was important, as markets have lately excessively discounted the Fed’s willingness to move rates at all, in our estimation.
Second, we think the majority of FOMC voting members would like to execute another rate hike in the near future, as that would be consistent with a deliberate policy rate normalization path in the context of lower than historic levels of natural interest rates (lower R*), the estimates of which continue to be shifted downward. Interestingly, the three votes against yesterday’s statement, from Esther George, Loretta Mester, and Eric Rosengren, depict this shifting balance of opinion within the Committee as well. The re-introduction of the language that “Near-term risks to the economic outlook appear roughly balanced,” is a clear indication of this shift to us, as of course was the explicit acknowledgement that “the case for an increase in the federal funds rate has strengthened.”
December moves likely
Still, with the next FOMC meeting coming nearly a week before a highly contested general election on November 8, we believe the Committee is unlikely to move in November, but the probability of a rate move at the mid-December meeting has been elevated. This is probably the only near-term exception to the idea of each meeting being “live,” as the Fed will not want to be seen as influencing political outcomes. Of course, any policy move is dependent on the continuation of decent domestic data and the avoidance of external shocks to the economy or markets.
Importantly, we think there is a very significant subtext to the Fed’s policy stance, in that it implies that the central bank will allow inflation to run hotter than it has historically. The Fed is likely to take this stance due to: 1) the lack of satisfaction with pre-existing inflationary expectations, 2) a potential growth/output function that is organically lower (attributable to demographic headwinds and technological disinflation), and 3) a greater set of policy tools that can be employed to bring down inflation, as opposed to those geared towards increasing it. Further, it is particularly likely because the Fed’s room to maneuver is limited by already very low policy rate levels.
And as we have argued many times in the past, the utility of extraordinarily low-interest rate levels has long since passed much effectiveness in stimulating real economic growth and for some time now has solely been influencing the financial economy as a price-supporting mechanism. Remarkably, the Fed last cut its policy rate in December 2008, and in the 62 FOMC policy meetings since that time, it has only moved rates once (a 25 basis point hike last December), while the economic, employment, and financial market landscape has changed markedly throughout this time. Thus, as we have also long argued, the baton must now be transferred from monetary authorities to the fiscal channel, if we are to see any meaningful re-rating of economic growth in the U.S., and further stabilization of global growth as well. Of course, the possibility of future fiscal policy support, and even the continuation of extraordinary monetary policy, both have political elements to them, and the degree to which the asset inflation of recent years has benefitted the already wealthy and left middle classes behind, relatively speaking, could well influence the policy path forward via the ballot box.
Wait and See
Finally, the extraordinarily easy financial conditions across the globe (particularly stemming from the ECB and BoJ policy mix) are stabilizing regions that had experienced some significant stresses in the year’s first half, which in turn reduces the left-tail risks for U.S. growth prospects. That has allowed the Fed to continue its “wait-and-see” approach for the time being, and as mentioned it raises the probability for a December move.
Turning to other central bank actions, yesterday the BoJ announced a policy adjustment that seeks to effectively adopt a yield target at the 10-year part of the curve at the same time announcing an intention to overshoot the 2% inflation target in an intentional manner. Part of the intent here is to modestly steepen the yield curve, which should help bank and insurance company profitability. Additionally, we do not believe that the BoJ decision to not cut rates at this meeting results in a sharp appreciation of the yen, as the expectation of further rate cuts remain, and overall markets appeared to take the policy announcement well. As the BoJ and ECB continue to remain highly accommodative, and in ever more innovative ways, the Fed will continue its slow march toward policy normalization, keeping the theme of rate divergence firmly on the table. BM
Subtitles and title edited by BENCHMARK editor