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Rate reflections

14 January 2016

Divergence in global monetary policy is likely to characterise the year ahead.

As if to quell lingering doubts before the end of the year, central bankers in the developed world evidently chose December 2015 to confirm that global monetary divergence was to be expected in 2016.

While the Federal Reserve introduced its first rate rise in nine years, both the Bank of Japan (BoJ) and the European Central Bank (ECB) signalled that they planned to continue with easing – perhaps even for longer than formerly indicated. Keeping a low profile somewhere between the two, the Bank of England declined to provide clear guidance.

The most decisive action came from the Fed on the 16 December, and it is the Fed’s rate decisions that are liable to have the greatest impact on both global growth and, more specifically, emerging markets. Although views varied on whether the central bank was right to raise rates at all, there was much relief on markets that some clarity had been achieved at last – the rate rise uncertainty of previous months was a major contributor to stock volatility in the second half of 2015.

Yet despite the clearer direction, this first rise does not signal a return to the familiar rate-rise trajectories of before the financial crisis, according to David Page, senior economist at AXA Investment Managers.

“The Fed move marks the start of the normalisation process but it will be a very long and drawn-out process compared to historic norms,” says Page. “The Fed is likely to move more or less as it predicts, rather than as the market predicts – 2016 will be an interesting game of cat and mouse.”

According to the Fed’s own ‘dot plot’ of predicted rate moves, it will make four quarter-percentage-point rises over the course of the year – one every three months, starting in March. But the futures market is predicting fewer rises. This mismatch has sparked criticism of the Yellen administration. Page believes that, while some of the mismatch is due to technical factors, it also illustrates that the Fed has lost some credibility over its forward guidance.

The problem with the mismatch, says Page, is that if the market does start to believe the Fed’s dot plot, then Treasury yields will start to rise – and that could end up staying the Fed’s hand, for fear that yields become too high.

As it happens, Page expects the Fed to move only slightly less than the dot plot implies over the course of 2016.

“Our baseline call is that the Fed might delay in March – we forecast three rate hikes this year,” he says. “Once a quarter is a bit optimistic and would put pressure on the dollar. We’d expect a similarly slow dynamic in 2017 – irregular hikes over the next two years.”

Studies comparing the rates tendencies of the four outgoing 2015 members of the Federal Open Market Committee (which sets rates) with those of the four incoming 2016 members have generally found new members to be more hawkish than their predecessors. What about the Bank of England?

“We think it will hike but there is no promise,” says Page. “The oil price will continue to have some influence as well and could delay a rise. Having said that, the downward move in the oil price is close to exhausting itself.”

About-turn

Page expects both the ECB and BoJ to continue easing through 2016. That path means that the major central banks of the world will be pointed in different directions.

“Divergence does happen occasionally – as in 1994 or 2002 – but the last fifteen years have made it look unusual,” he says. “We would expect the dollar to rise further this year, especially against the euro and yen.”

“The other side of the coin is that when the dollar rises you see capital flows into the US, which reduces the long-term borrowing rates in the US. You’d see the dollar rise but the increase in long-term rates is likely to be subdued, which provides something of a tailwind for US economic activity,” says Page.

 

 

David Page is senior economist at AXA Investment Managers. The opinions expressed are those of David Page and are subject to market or economic changes. This material is for information only and is not a recommendation or intended to be relied upon as a forecast, research or advice. The views are not necessarily shared by St James’s Place investment managers or by St. James’s Place Wealth Management.

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