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Fed rate hike ushers in new era for investors


The rise in the Federal Reserve’s interest rate yesterday was not unexpected, particularly on the back of strong jobs data and forecasts that US inflation is heading towards its target. But it marks a significant point in the journey of the global economy away from the low interest rate, low inflation environment we have been enjoying for so long.

For active investors and professional money managers alike, it means changing the habits of almost a decade.

“Rates are beginning to normalise,” explains Nigel Green, CEO of deVere Group. “Whilst it may take a couple of years or so to get there, when they do, the global economy will look very different to how it looks today.”

The shifting landscape means investors will need to review whether they are really diversified. Being truly diversified across asset classes, sectors and geographical areas, and not trying to be too smart with sector and regional bets, is going to be critical.

“The traditional relationship between sectors and regions has diminished since President Trump took office,” Green adds. “A lot will be resting on which way the greenback heads and crucially, which policies will be green-lit by Congress.”

Green also warned that higher Fed rates will attract overseas capital back into the United States, especially to sectors like energy or financials that will be most likely to benefit from Trump’s policies.

Is there more to come?

Well yes, there is. Despite the rate increase, the Fed has maintained its emphasis on the need for ‘accommodative policy’: it means more interest rate hikes on the horizon, including this year. Markets were still a little surprised by the rate rise, as there had been a widespread belief that the Fed would raise rates four times in either 2017 or 2018. Instead, the US central bank is maintaining its forecast of three hikes this year, and three hikes next year.

“We believe that inflation is rising more quickly than many appreciate,” says Ken Taubes, head of US investment management with fund manager Pioneer Investments. “Both headline CPI [consumer price inflation] and wage inflation are trending upward, in an environment with little labour market slack.”

Driven by a doubling of oil prices, headline CPI in the US has risen by 1% over the past year to its current 2.7% level. The major components of shelter and healthcare have risen even more. Core PCE, which is the preferred measure of inflation used by the Fed, has risen to 1.9%, year-over-year through January, up from 1.6% in December.

And prices have not only risen on the consumer side – on the industrial side, the producer price index increased 3% year-over-year in January, versus -1.2% year-over-year in January 2016.

All this means that the wind remains in the sails of the US equity bull market. From a technical analysis perspective, broker XTB said this morning it was seeing no bearish reversal signals on smaller time frames, and that “therefore a leg higher towards a new higher high seems to be a matter of time, especially as a new higher low has probably been formed on a daily interval.”

So what next?

“One can look at the interest rate markets and see that the Fed funds future is not fully pricing in a second hike this year until September, with a June 50/50 proposition,” says Chris Weston, Chief Market Strategist with IG in Melbourne. “It really does suggest that the Fed hurried this hike through to take advantage of favourable equity and credit pricing.”

The economic figures coming out of the US are certainly pointing in the direction of more hikes this year, and we would not be surprised to see two more before the end of the year, as the Fed seeks to keep inflation in the US under control.

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This article does not constitute investment advice. Make sure you do your own research or consult a professional advisor.

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