The minutes from the US Federal Reserve’s October policy meeting have mixed implications for investors, even amid mounting expectations among economists and market participants that the central bank will raise interest rates next month for the first time in almost a decade.
The text does show that members of the Federal Open Market Committee believe it may well become appropriate to “initiate the normalisation process” at its next meeting.
But this view comes with some conditions: as long as there are no unanticipated shocks that do not adversely affect the economic outlook; that data support the expectation that the labour market continues to improve; and that inflation will return to the committee’s 2 per cent objective over the medium term. Moreover, some officials saw it as unlikely that the information available by the December meeting would warrant a rate increase.
Bond markets, meanwhile, are pricing in a rate increase next month with a high degree of probability, which also explains much of the weakness in fixed income of late. However, given the tendency of liquidity in those markets to dry up around year end, is it certain that the Fed would risk triggering unforeseeable dislocations with such a move then?
Elsewhere, the precipitous decline in copper prices – a good leading indicator for global growth – suggests the economic outlook may be far from rosy. Weak US retail sales and housing data may also raise concerns among Fed officials about the domestic recovery.
Against this backdrop, a rate increase is far from a done deal. As such, we have added to our stance on duration, paring a previous underweight position. Bonds may be expensive, but they are one of the few assets investors would want to own in the event of a deflationary bust, which is still a real risk for the global economy.
Anthony Gillham is co-investment director at the multi-asset unit at Old Mutual Global Investors.