The Fed Ploughs Ahead
Nicholas Wall, portfolio manager, Old Mutual Strategic Absolute Return Bond Fund, Old Mutual Global Investors, comments:
- This was widely expected; the Fed had wanted to get the process of balance sheet reduction underway before its composition changes next year. The strong economy and loose financial conditions also gives the central bank confidence that the market will be able to handle the extra bond issuance.
- The Federal Open Market Committee’s (FOMC’s) economic projections, or dots, were largely unchanged despite recent low inflation prints. This suggests that the majority of the FOMC’s members see the drop in inflation as transitory and Governor Lael Brainard’s fear of lower trend inflation has not yet percolated through to the rest of the committee. This means that a December interest-rate hike is well and truly in play.
- Neither of these moves should be enough to derail the economy. Household balance sheets, in aggregate, look healthy, debt service costs are low and employment is high. The bigger risk is likely to be in asset markets.
- However, the Fed entrance and exit policies will be asymmetric in nature. On the way in, the Fed’s policy was shock and awe as it sought to stave off Great Depression 2.0. On the way out, it wants to be predictable and patient so as not to disrupt markets – especially with the Fed itself sitting in the political crosshairs.
Therefore, while inflation stays at a low level, the Fed has the luxury of being patient, as with most developed market central banks. Should inflation rise and central banks are inclined to act more quickly, then a buoyant market may face a bigger test.