In it I argued, among other things that, when it hiked 12 months ago, The Federal Reserve might well have ‘gone too soon’; that there was a genuine risk its rate hike trajectory would be ‘one and done’.
For most of 2016 that looked like it could well end up being the case; the sprouting evidence of wage growth, counterbalanced by worries of a continuation of poor earnings and a global outlook of ongoing lacklustre growth.
As we head into the last Federal Open Market Committee (FOMC) meeting of the year, however, all that has changed. Not only is it almost certain the Fed will raise rates when it meets next week, but the surprising election of Donald Trump to the White House has raised expectations that a few more are possible.
Boom, bust or both
As Chris Iggo, fixed income chief investment officer at Axa Investment Managers wrote in a note on Friday: “The worldview has changed from the prevailing “lower for longer” view of interest rates to “boom, bust or both”.
Much ink has already been spilled on debating whether or not Trump will succeed in achieving even the least wild of his claims about boosting economic growth to 4% but, as Iggo points out, whether or not he can achieve it does not really matter: “It is the risk that he can that is driving things”.
Part of the problem for investors is the asymmetry within fixed income markets, with yields close to all-time lows, the risks inherent in betting against his success are much higher than the rewards for those vindicated by his failure.
As a result, Iggo said, expectations of interest rates in 2017 and 2018 are much higher now than they were on November 7th.
“At least one bank is forecasting that the Fed Funds rate will be at 2.0% by the end of 2018 – taking it back to zero in real terms if inflation continues to rise. I am not sure that the bond market has fully priced in the implications of the main policy rate being increased by 150 bps in the next two years. This won’t be a 1994 rout but it could just be as painful for those investors that have locked in to low yielding assets in recent years.”