Comments on yesterday’s Fed policy statement: ..
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Rick Rieder, Chief Investment Officer of Fundamental Fixed Income at BlackRock, and Co-Manager of Fixed Income Global Opportunities (FIGO)
· At the close of its July meeting, the Fed released a mildly hawkish statement that continues to strike a balance between its “wait-and-see” approach and the increased likelihood for one rate hike before year end.
· Nevertheless, in our estimation, 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.
· That suggests that 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. This possibility brings with it a great deal of uncertainty, as its probability has as much to do with political events as it does economic common sense.
A Mildly Hawkish Turn at the Fed Leaves the Door Open for a 2016 Hike
The Federal Reserve Federal Open Market Committee (FOMC) announcement marked the first of four significant central bank meetings that take place over the next several days, and perhaps not surprisingly the theme of global policy divergence is again on the table. That’s not because the Fed’s statement was excessively hawkish, although it was mildly so, but rather because the Fed both continues to recognize that U.S. economic data remains stronger than that seen in much of the rest of the world and as stated that “near-term risks to the economic outlook have diminished.” Further, extraordinarily easy financial conditions across the globe are stabilizing regions (Europe and emerging markets, for instance) 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, which also seems calibrated to leave the door open to some small degree of interest rate policy normalization this year, including possibly in September. Of course, the pace of that change has been profoundly altered since the December 2015 meeting rate hike.
Still, in our view, 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. Thus, as we have 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 left the middle classes behind, relatively speaking, could influence the policy path forward via the ballot box.
Fascinatingly, we think the seeds of further political volatility will continue to be with us, as labor and income dynamics get more difficult at the margin in many parts of the globe. In fact, according to some market analysts, it is historically speaking not unusual to see a delayed political reaction that results from major financial crises, such as that seen in 2008, so the rise in populist sentiment (for example, with the Brexit vote in the U.K., and political campaigns in the U.S.) should not be a surprise. The fact is that this very real discontent is largely the result of an uneven recovery. So, almost regardless of where an investor is located around the world, political event risk is vital to keep a close eye on, even if estimating that risk has become very difficult of late. Of course, in addition to the U.S. elections on November 8, we would particularly take note of the Italian constitutional reform referendum that is scheduled to also take place later this year, as well as the next German federal elections in late-summer 2017.
We think much more interest rate policy normalization this year may be difficult for the Fed to accomplish, particularly should jobs growth continue on its slowing trend, inflation expectations and realized inflation remain fairly moderate, and both domestic and international political risks continue to unsettle financial markets. Thus, unless we see a significant improvement in economic data, further stability in global financial markets, and a meaningful pickup in inflation measures, we are likely to see only one more rate hike this year, with the year’s last third as the most likely time for it.