An update on the US rate rise

Dr Shane Oliver
Head of Investment Strategy and Economics and Chief Economist
(AMP Capital)
12 October 2018

 

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Although we’ve seen declines on Wall Street this week, there’s still strong growth in the US market. The most recent rate hike in the US may have investors concerned that the Fed could threaten markets with even more aggressive hikes.

But I don’t think that is likely; I expect the Fed will continue raising interest rates at a gradual pace.

The latest 25 basis point rise takes the US key central bank interest rate to a target range of 2% to 2.25%. That’s the 8th rise in this cycle which started back in March 2015, and the Fed’s rate hikes have been coming every three months.

What is certain is that there are more rate rises to go. The Fed has indicated it wants monetary policy settings to be ‘neutral’. Neutral means interest rates are neither stimulating or restraining growth.

The Fed doesn’t seem to know precisely where neutral is, but it is likely to be somewhere near 3%. That means they will keep raising rates every three months until we get around that neutral zone. So we’re looking at another hike in December and one again in March next year.

Strong US economic data, however, has some fretting that rates will rise more quickly. There is no doubt the US economy is performing well. August employment growth was revised up by 69,000 jobs, taking it to a very strong 270,000 jobs, and unemployment fell to a 48 year low of 3.7%.

But at this stage I don’t see the Fed accelerating the pace of tightening because, while inflation pressures in the US have built up, they are not intense.

Yes unemployment has fallen, but wages growth has slipped back to 2.8% year-on-year from 2.9% and is still relatively benign. Indeed, wages growth remains in a gradual rising trend, which is consistent with the US Federal Reserve continuing to raise rates every three months.

Wages growth is still a long way from the 4%-plus growth rate that helped drive the tight US monetary policy which preceded the last three US recessions.

Overall, the Fed has got inflation around its 2% target so there is no need to get too aggressive with rate rises. It’s really just about returning policy to a neutral zone.

At some point, perhaps in late 2019, more likely 2020, rates will go above neutral and that might cause a downturn in the US economy. But it’s still a fair way off.

So in the short term, the US economy is in good shape; growth is very strong, but inflation is relatively benign and around target. That keeps the Fed raising interest rates at a gradual pace.

 

Important notes

While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided.

 

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