The US Fed needs to raise rates further so they can cut them again when US growth slows down in 2018 or 2019, says Dickie Hodges, head of unconstrained fixed income at Nomura.
The central bank rose rates by 25bp to 1.25 per cent at its FOMC meeting that concluded on Wednesday.
“There is a possibility they raise two more times,” says Hodges, which he argues is not priced into government bond yields.
“The reason why is nothing to do with inflation, nothing to do with growth. The US economic data coming out more recently has been on the soft side. It’s definitely later cycle there.”
Hodges expects US and global growth to slowdown next year.
“The Federal Reserve need to get interest rates higher so they can cut them again either in 2018 or 2019.”
“They’ve seen the effects of negative interest rates around the world that are doing more harm than good,” Hodges says, adding: “They’ve got to get them up high so they’ve got that firepower to support an economy that starts really deteriorating.”
Hodges says he under no illusion that Donald Trump’s plan to repatriate tax will boost the US economy and says it will instead provide a one-off boost for shareholders and M&A activity.
In contrast, Anna Stupnytska, global economist at Fidelity International, sticks by her forecast that the Fed will not raise rates again this year despite interpreting the FOMC statement as “relatively hawkish”.
“Any acceleration in wages and inflation is likely to be gradual, meaning the Fed will be under little pressure to tighten policy in the next few months.”
Normalisation will fail
Hermes Investment Management group chief economist Neil Williams says the Fed will “try, but fail” to normalise rates anywhere near their historic average.
Williams predicts a ‘peak’ rate under 2 per cent due to delayed tax cuts, potential protectionism and the lagged effects of previous hikes yet to come through – a process that generally takes 18 months to hit consumer spending in full.
The historic interest rate average is 5 per cent.
“The Fed remains the test case for whether central banks can ever ‘normalise’ rates. We expect it to try, but fail – hiking the funds target just once or maybe twice more in future forecast-round months.”
Williams expects the Fed to implement quantitative tightening later this year.