Federal Reserve chairman Jerome Powell faces increasing pressure from U.S. President Donald Trump - as well as nervous investors - to abandon his interest rate hiking cycle. Powell has delivered four rate hikes during his 11 months on the job, the latest being greeted by jeers from stock market participants as the S&P 500 dropped more 2% in response.
Speaking on Christmas Day and addressing rumours he’s considering firing Powell, Trump re-iterated his belief that the Fed is “raising interest rates too fast”. He added, however, that he was “confident… it will straighten” and noted his belief they are raising rapidly “because they think the economy is so good”.
After the latest rate hike in December, the Fed signalled it would become less aggressive in the coming 12 months, with the number of expected rises reduced to two, from three, and the longer-term expected interest rate reduced by 25 basis points to 2.75%.
Still, analysts are split over how many times the Fed will go. The general feeling remains two to three hikes before a pause halfway through the year, but some are predicting a cut.
Russell Silberston, co-head of developed market FX and rates at Investec Asset Management, puts the probability of two hikes at 35%. He says it’s more likely, a 55% probability, that we’ve already reached peak interest rates for the current cycle.
No interest rate rises priced in
That’s an opinion backed by the market, which is pricing in zero increases for 2019. This reflects “the fears that are affecting markets rather than the statements and guidance from the central bank”, notes Sandra Holdsworth, head of rates at Kames Capital.
The Fed is three years into its tightening cycle, which now includes the reversing of quantitative easing, its bond-buying programme. Aviva Investors notes that it is the second-longest tightening cycle in the past 50 years, with the average cycle lasting just 15 months.
That highlights just how unusual the present episode is, the firm adds. “After almost a decade in maximum stimulus mode and in a post-crisis environment, it is entirely sensible for central banks to take their time in withdrawing support.”
It’s a difficult position for the Fed to be in, says Oliver Blackbourn, a manager on Janus Henderson’s UK-based multi-asset team. Investor concerns over a looming US recession should herald lower interest rate expectations. “However, for the Fed to cut interest rates, it would need to admit that the economy is rolling over, which is contradictory to their own forecasts,” he adds.
Another consideration, which the Fed looks to now be acknowledging, is the effect rising US rates has on the wider global economy. Most emerging nations and companies hold US dollar-denominated debt, which becomes more expensive to service as the greenback edges higher with each hike.
“Slower interest rate rises may take some of the steam out of the US dollar rally, easing financial conditions for those in the rest of the world that are dependent on the greenback for funding,” continues Blackbourn.
Reccession probability
The yield curve may also play on bankers’ minds. In early December, the US three-year Treasury yield rose higher than the two-year yield. An inversion of the curve like this, when longer-term bonds pay investors a higher coupon than shorter-term paper, is a key signal a recession is on its way.
The inversion at the short end of the curve has become sustained, with the one-year bond yielding more than the two-year bond, which, in turn, yields more than the three-year to Wednesday 2 January.
But most commentators aren’t panicking just yet, preferring to rely on the spread between the US two-year and US 10-year yields, which tends to invert 18 months in advance of a recession.
Trump, too, is worried about the probability of a slowdown, says Neil Dwane, strategist at Allianz Global Investors. But that will just serve to make him even more determined to keep the economic expansion going until the next Presidential election in 2020, says Dwane.
He notes that the only US President to run for re-election with a looming recession was George W Bush Senior, who lost the vote. Therefore, Trump will “fight to keep the US economy on track”. That includes continuing to fight the Fed on monetary policy.
“I think it’s highly likely that Trump may try to do a deal with the Democrats,” adds Dwane. “He might try to do some infrastructure spending, or some healthcare reform – all of which is designed to try and keep the US economy going until November 2020.”
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