At its meeting this week the US Federal Reserve (the Fed) lifted the target range for its federal funds rate by 0.25 per cent – the first increase since June 2006. This move was widely expected by markets and economists, and as a result the reaction so far has been fairly muted.
Still, this represents a significant departure point for US monetary policy. It’s a strong signal from the Fed that after significant headwinds to growth and inflation, the recovery in the US is sufficiently progressed and robust that it can withstand some removal of policy accommodation. It’s important to note that monetary policy in the US is still extremely stimulative. The Fed’s Quantitative Easing program will not be unwound for some time and interest rates are still very low by historical standards.
The Fed currently expects it will increase interest rates four times in 2016, to between 1.25 and 1.5 per cent (see red dots in above chart)., while the market has only two rate increases priced in during that period. Even four rate increases next year would represent a much slower path of policy normalisation than has occurred in the past. This slow pace of normalisation reflects a number of things:
While inflation remains below target (as it currently is), expectations of future rate increases by the Fed are likely to be fairly muted. We’ll keep a keen eye on price pressures in the US economy in order to gauge the likelihood that the Fed will have to move faster (or slower) than is currently expected by markets. Our portfolio objectives are most likely to be met if the coming period is one of contained inflation, robust economic growth and only a modest normalisation in interest rates. Portfolio outcomes are likely to be hindered by either a very fast normalisation in interest rates accompanied by higher inflation, or a sharp downturn in economic growth. Fortunately, we don’t think either of these risks are as likely as the favourable scenario.
This post is our last in 2015. We hope you’ve enjoyed reading our blog this year and we look forward to sharing more of our thoughts with you when we return in January 2016. In the meantime, from the QSuper Investments team we wish you a safe and happy Christmas.
The views of the author and those who provide the responses to comments posted on this blog are not necessarily the views of the QSuper Board. We’ve put this information together as general information only and you should get professional advice before relying on this information.
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