US Fed must learn from Japan and Europe in rates decision


The US Federal Reserve has become “too comfortable” and needs to take a lesson from the Bank of Japan and the European Central Bank when it makes its interest rate decision this week, a fixed income specialist from Neuberger Berman argues.

Chief investment officer for fixed income Brad Tank says he wants the Fed to be “courageous enough to surprise the market again”.

“The European Central Bank and the Bank of Japan still occasionally show us how it is done,” Tank says.

“Mario Draghi’s ‘whatever it takes’ intervention – was the ultimate in central bank policy-by-messaging. Its announcements in March this year approached those heights, too, as did the Bank of Japan’s plunge into negative rates.”

Markets are currently pricing in a 20 per cent chance that the central bank will raise rates at its meeting this Wednesday, down from 50 per cent earlier in the month.

Hawkish comments by US Federal Reserve Bank of Boston President Eric Rosengren sent markets reeling earlier this month, with the S&P 500 falling 2.45 per cent in one day and the FTSE 100 falling 1.5 per cent several hours after it opened the following Monday.

However, US Federal Reserve official Lael Brainard calmed markets several days later when she warned the central bank should act with “prudence” at this month’s meeting.

“The Fed has for too long been in a too comfortable position, with decent job creation and some growth and inflation,” Tank says.

Ketan Patel, portfolio manager at EdenTree Investment Management, predicts the Fed will “keep flexibility on the upside and hold rates in the absence of headwinds”, but would limit any hike to 0.25 per cent if it did decide to surprise markets.

“Rate hikes normally signal the emergence of a stronger economy – falling unemployment, increased bank lending, growing corporate profits, rising wages and a strengthening housing market – all of which are emerging in the US, but in varying strengths.

Fabrizio Quirighetti, co-head of multi-asset at SYZ Asset Management says market expectations about the US’s monetary policy path makes it difficult for the Fed to “normalise rates without automatically triggering the uncertainty that would in turn require easing back”.

“Fortunately, talk is cheap and we suspect Fed members will use rhetoric to ease or tighten at the margin, or at least restore some uncertainty regarding its intentions.”

Quirighetti says central bankers have pushed asset prices higher despite concerns over valuation levels and geopolitical risks.

“While this has served to postpone or reduce deflationary pressures, it has failed, once again, to reflate the economy. In other words, the many troubles and concerns haven’t really disappeared; they have just been drowned again in the Fed’s massive punch bowl.

“If we are right, it means that September may be an inflexion point to recent market trends: we don’t expect a strong reversal of these trends but just some pause. In this context, the dollar may stop weakening, rates should grind marginally higher, spreads shouldn’t tighten further and emerging markets outperformance could be challenged.”