The end of US rate hikes?

30/01/2019

The Federal Reserve held its benchmark rate steady and said it would take a wait-and-see approach to future rate hikes. Co-Head of Global Bonds Nick Maroutsos believes the central bank’s decision likely signals the end of the tightening cycle in the US.

Key takeaways

  • The Federal Reserve (Fed) left its benchmark rate steady in the range of 2.25% to 2.50%.
  • We believe the Fed’s decision marks the end of the current tightening cycle in the US.
  • In light of the Fed’s shifting position, we believe bond investors can take advantage of a lower interest-rate environment, not only in the US but in other countries that are likely to hold rates steady.

On 30 January 2019, the Federal Reserve (Fed) announced that it would be holding its benchmark rate steady in the range of 2.25% to 2.50%. In addition, the central bank signaled that it would take a “patient” wait-and-see approach to further rate hikes in light of market volatility and cross-currents that could impact global economic growth. It also said it would maintain an “ample supply” of reserves, relying primarily on the federal funds rate to drive monetary policy, not balance sheet reduction.

So where does that leave us? We believe the Fed is done hiking – not for 2019, but for good.

During the Global Financial Crisis of 2008, the Fed took two important steps: slashing interest rates to zero and flooding the market with liquidity, an approach collectively referred to as quantitative easing, or QE.

Through QE, the Fed was able to help the US economy emerge from the worst economic crisis since the Great Depression. More than a decade later, we think quantitative tightening – the reverse of QE – will be a tougher policy experiment to get right. Since late 2015, the central bank has raised the federal funds rate nine times to 2.50% and, more recently, simultaneously unwound its balance sheet. Now, the Fed could be signaling a change.

In fact, we feel it will take significant positive data for the Fed to turn hawkish again. The economy is not firing on all cylinders and inflation is relatively nonexistent as prices have now become less linked to decreasing US unemployment. Geopolitical risk is elevated, as politically we face further gridlock in Washington, D.C. We think a potentially stagnating economy and geopolitical risk keep a cloud over growth prospects.

As a result, the front end of the US yield curve may benefit as the likelihood of curve steepening has increased. By contrast, we expect longer-duration bonds in countries such as Australia and New Zealand, which have comparatively attractive yields to the US, to be well positioned in the current environment. (Duration is a measure of a bond’s risk to changing interest rates.) We think investors should slowly redirect that duration back to the US as our outlook on rates continues to be validated.

To be clear, although we are forecasting an end to rate hikes, we do not believe the US economy is headed for a major downturn or recession. In our opinion, numerous opportunities appear in the bond space, particularly in high-quality names in Australia, Asia and the US.

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