Monetary policy is probably the single most important factor that influences markets today and the FED is by far the most influential central bank in the world; therefore it is crucial to understand its policy in order to forecast equities and bonds performance.
Two months ago, the market expected rates to rise in June, a couple weeks ago everybody was pointing at September and now most analysts are talking about the last week of November. The market is pushing expectations for the first rates hike further away as time passes and we have 3 solid reasons to believe it will not happen this year.
1) Low inflation
The FED has a desired target of 2% inflation, while inflation is currently 0%. This is mainly a temporary effect due to very low oil prices, but even if we look at core inflation, it is 1.7% YoY, still below the FED’s target. Moreover, ten year inflation expectations are just 1.81%, very close to their 5-years low and once again below the FED’s target.
As inflation represent a core element in the FED’s dual mandate, we believe that the FED will not raise rates until inflation expectations will come in line with the target.
“The U.S. Federal Reserve may not increase interest rates in 2015 due to weak inflation and risks to the economy due to a surging dollar after the central bank downgraded its economic forecasts.”
Morgan Stanley’s chief U.S. economist Ellen Zentner
2) Weak growth
US growth looks very fragile after a strong 2014. The Atlanta FED has recently cut US GDP forecasts for Q1 2015 to 0% and the job report last Friday has trailed analysts expectations with just 126,000 jobs created in March, marking the first number below 200,000 in 14 months. Consumer spending, that accounts for two thirds of US GDP is also very weak at +0.1% in February.
Although unemployment fell significantly over the past years, it is currently at the higher end of what the FED considers a “long-run normal rate” between 5.2% and 5.5%. Moreover, lower unemployment has not yet translated into higher wages and the long-awaited acceleration in wage growth is yet to be seen.
“The economy is growing, but it’s not doing so at a particularly fast pace, it will be hard for the Fed to raise interest rates in this type of environment.”
Jim Lacamp, senior vice president of investments and senior portfolio manager at UBS
3) A strong dollar
The dollar index is at 96.74, close to its all-time highs and has risen more than 20% in the past 12 months; this is seriously hurting U.S exporters, that have reported disappointing results in the first quarter. Although the FED does not explicitly target the exchange rate, nor companies earnings, these factors have a huge impact on future growth and unemployment.
“The US Federal Reserve could refrain from hiking interest rates this year, and could defer the move to late next year. A fourth instalment of the Fed’s aggressive quantitative easing (QE) programme could be on its way.”
Nomura strategist Bob Janjuah
If the FED delays the first interest rates increase to 2016, it would be good news for US stocks, but we believe the decision would be even more favorable for emerging markets equities that would benefit from more capital inflows and a less expensive external debt, thanks to a lower dollar. The Dollar bull market may have come to an end.
Niccolò Bardoscia
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