Why we are not afraid of the Fed
Global growth is picking up, and the Fed seems unlikely to disrupt the momentum
The Federal Reserve (Fed) raised interest rates in March and is likely to raise them again twice this year, yet the financial markets have taken this news in stride. Why is this? Simply put, the Fed is behaving dovishly, considering the positive growth pattern we are seeing.
We are in the midst of a global growth pickup that began in the second half of last year. The three largest economic blocs — the US, Europe and China — are showing solid growth.1
- In the US, a pickup in expectations and “animal spirits” due to the US election in November has boosted growth to above-trend levels.
- In Europe, monetary stimulus has supported domestic growth, and the eurozone economy is now also growing above trend after lackluster performance in recent years.
- The Chinese economy stabilized at the end of last year, and it too is showing upside growth momentum.
For the first time since the global financial crisis, we seem to be in the midst of a solid growth upswing among the world’s major economies.
Growth on its own is a positive for credit assets and risky assets such as equities, as their fundamentals are tied to the productive output of the economy in many ways. The potential negative is if policymakers tighten policy in response to this growth impetus and cause adjustments in asset prices.
Recent Fed statements appear to have reassured the markets
This is where the Fed’s recent statement and commentary are reassuring, in the view of Invesco Fixed Income. The Fed indicated that it is unlikely to aggressively tighten monetary policy soon. Indeed, in its March statement, it stressed the concept of symmetry around its inflation target. In other words, the Fed does not view its stated inflation target of 2% as a ceiling, but rather is willing to allow inflation to run higher than the target for an extended period. This implies that it will likely be patient in raising interest rates — and is unlikely to take the proverbial “punch bowl” away in the near term.
Likewise, we expect the European Central Bank (ECB) to be patient with its quantitative easing (QE) program as political risks remain in the eurozone. The Bank of Japan (BoJ) is committed to its Yield Curve Control (YCC) policy for the time being as well, in our view.
The bottom line: Improving growth combined with accommodating policymakers is good for most risky assets, in our view, and we have seen risky assets perform well, even as the Fed hikes rates.
Invesco Fixed Income’s view
Our macro factor framework — which provides the basis for much of our investment strategy work — seeks to understand the likely behavior of financial markets by isolating the impact that growth, inflation and financial conditions have on the markets. Currently, our view is that growth is showing upside momentum, inflation is well-contained, and financial conditions remain stable. Based on this, we expect to see upward pressure on global duration as real rates rise somewhat, relatively solid fundamentals for credit markets supported by growth, and a neutral view on the US dollar versus developed market currencies. Global growth is also supportive for emerging markets (EM) at the margin, so some EM currencies may see appreciation versus the dollar.
What could bring this rosy scenario to an end? At this point in the cycle, the primary risk would be an aggressive tightening of financial conditions. If central banks change their tune and become concerned about inflation, they could begin to tighten policy. That would change the picture and warrant caution on risky assets. But until they take the punch bowl away, we aim to stay long.
1 Sources: Bloomberg L.P., Invesco, data from June 30, 2016, to March 30, 2017
Blog header image: radiorio/Shutterstock.com
The yield curve plots interest rates, at a set point in time, of bonds having equal credit quality but differing maturity dates to project future interest rate changes and economic activity.
Fixed income investments are subject to credit risk of the issuer and the effects of changing interest rates. Interest rate risk refers to the risk that bond prices generally fall as interest rates rise and vice versa. An issuer may be unable to meet interest and/or principal payments, thereby causing its instruments to decrease in value and lowering the issuer’s credit rating.
The risks of investing in securities of foreign issuers, including emerging market issuers, can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.
Robert B. Waldner, Jr., CFA
Chief Strategist and Head of Multi-Sector
Rob Waldner is Chief Strategist and Head of Multi-Sector for Invesco Fixed Income (IFI). Mr. Waldner has overall management responsibility for the IFI public credit asset class teams and the Multi-Sector team. In this role, he is responsible for oversight of the portfolio construction process for IFI’s public security portfolios. Mr. Waldner chairs the IFI Investment Strategy team and is responsible for oversight of the overall IFI investment process. He joined Invesco in 2013.
Prior to joining Invesco, Mr. Waldner worked with Franklin Templeton for 17 years. At Franklin Templeton, he was a senior strategist and senior portfolio manager. He was the lead manager for Franklin absolute return strategies, and a member of the Fixed Income Policy Committee. Mr. Waldner was instrumental in the launch of a number of new strategies on the Franklin Templeton fixed income platform. Previously, Mr. Waldner was a member of the Macro team at Omega Advisors and a portfolio manager with Glaxo (Bermuda) Ltd. He entered the industry in 1986.
Mr. Waldner earned a BSE degree in civil engineering from Princeton University, graduating magna cum laude in 1986. He is a CFA charterholder.