Our investment team round-up some of last week’s news…
Investors eagerly tuned into Jerome Powell’s first congressional testimony. The new incoming Federal Reserve Chairman Powell painted a relatively optimistic picture for the US economy, which policies the new Fed Chair will sponsor, and his views on the trajectory for interest rates, all of which will be scrutinised closely in the months ahead.
Janet Yellen, the previous Chairperson of the Federal Reserve, increased rates five times during her term (three times in 2017). Each time she raised rates by a quarter of a percent which is typical of the Fed’s steady as she goes approach.
Each rise in rates has been foreshadowed by concerns that the US economy would be inhibited from regaining full economic health. This week Powell put many of those concerns onto the back burner. He argued, “the economic outlook remains strong”, and “some of the headwinds the US economy faced in previous years have turned into tailwinds”. A big part of his reasoning appears to be associated with the stimulative fiscal policy (tax reform and budget spending) initiatives enacted by the Trump administration. Powell voiced that “further gradual increases” in the Federal Funds rate i.e. interest rates, would be appropriate.
Powell also reaffirmed that maximising employment and maintaining price stability are important objectives, but he carefully moderated his tone around inflation. The dilemma of inflation has been that until recently the global economic recovery had been shown to have little impact on improvements to real wage growth. Growth in pay has uncharacteristically lagged the strong improvement in employment conditions. However, with fiscal policy being deployed, to spur yet more economic activity, the Fed appear to recognise that inflation runs the risk of spiking. However, the Fed will continue to strike a balance between avoiding an overheated economy and allowing inflation to rise uncontrollably above the Fed’s target of 2%.
Following Powell’s address, the probability of an interest rate hike in March remained unchanged. However, the probability attached to the need for two, three and four quarter percent rate hikes over the course of 2018 increased, as illustrated by the chart below.
US Interest Rate Hike Probabilities
Source: Bloomberg, 01 March 2018
The Fed emphasised that interest rate hikes this year are data dependent, but officials indicated that a higher growth rate will not necessarily prompt the central bank to accelerate monetary tightening. They are obviously focused on inflationary pressures and how this will manifest.
Source: Trading Economics, 01 March 2018
Whilst being pressed on his approach to interest rate policy, market participants are also assessing Powell, versus his predecessor, regarding his attitude to financial deregulation. Powell responded to questions from members of the House that the Fed intends to relax regulation on banks. One possible change could be a reduction in capital requirements for some large banks, allowing them to rely more heavily on borrowed money, but “without losing any safety and soundness”. It seems the US sees an opening to lighten the burden of regulation, perhaps with a view to making their financial sector more nimble and able to compete globally. An interesting thought!
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