Markets Won’t See Taper Tantrum Replay On Further Fed Hikes, Says Richard Gibbs
U.S. lending rates seen between 1.25-1.5% in 2017, says market expert Richard Gibbs.
Further interest rate increases by the U.S. Federal Reserve this year will not significantly impact fund flows into emerging markets, said global market analyst and Principal at Plantagenet Investments, Richard Gibbs. He expects U.S. lending rates to hover in the 1.25-1.5 percent band, given the central bank’s target of two rate hikes this year after a hike in March.
“We’re not going to see the taper tantrum and the like replayed as we’ve seen previously,” he said in an interview with BloombergQuint.
The U.S. central bank kept interest rates unchanged in Wednesday’s monetary policy, as was widely expected. The commentary reaffirmed expectations of weakness in the U.S. economy in the first quarter due to political uncertainties but said any slowdown will be “transitory”.
Here are edited excerpts of the conversation.
Did the Fed’s move take you by surprise or it was along expected lines?
The Fed really just reaffirmed what people expected and that was to leave rates unchanged this time. I think the interesting point of the Fed’s exercise was really the accompanying statement that is clearly looking through the weakness of the first quarter and they are speaking rather bullishly on the outlook for the U.S. economy, and wanting to maintain the trajectory of the normalisation cycle, and that is really another two policy moves this calendar year.
Nothing in terms of data deterred the Fed in its statement nor did it excite the Fed to change its stance. Is there anything that took you by surprise?
Not really. I think (that’s) what you should expect from (U.S. Fed Chairperson) Janet Yellen as she is a labour and monetary economist, and she is focusing on the labour market. She talked about strengthening the labour market and firming up investments. So those are the two key pillars from a policy perspective. So no shock or surprises there. I think it was deliberate. I think it was the time and place for the Fed to basically want to emphasise on certainty and stability, given what has been going on internationally.
The Fed is probably trying to say that volatile indicators moving up or down in a month or in a quarter will not really have too big an impact on its decision. They are looking at the long-term trajectory of economic growth and the statement indicated that seems to be on the way up.
What they’re saying is that there are volatile indicators, in particular, in the first quarter. Consumer spending, as we all know, is reactionary and it’s quite conservative and there is uncertainty there. Not surprising that we saw some slackening in consumer spending in the U.S. in the first quarter.
We have a new administration that’s come into the White House and there is uncertainty there. Also key administration positions haven’t been filled. So there is policy uncertainty. There is geopolitical uncertainty also unfolding.
I think that means consumers are going to be fairly cautious in that first quarter. The important thing is the Fed is looking at the foundations and the quality of foundations for future growth and that really revolves around the labour market and business investments and getting that productivity growth back into the economy.
Would you presume that in June and September, or maybe some other month, but there can be two more hikes in this calendar year?
I think two more hikes is pretty much in line with what Yellen was reaffirming with the accompanying statement. We are likely to get the upturn of the year with the Fed funds target range of 1.25-1.5 percent. That’s not going to be extreme. That’s going to mean that interest rates will remain on the lower side and that’s what they want, to reinflate the economy.
There are some pleasing signs on the economy. They (Fed) really think it has turned the corner in relation to concerns about deflation and deflationary pressures in the U.S. economy. That’s positive as well. But at the same time, what the Fed is going to try to do is balancing the offsetting impact of a stronger U.S. dollar. They don’t want that to crunch the liquidity conditions that they are trying to boost in the U.S. economy.
What would be the 18-month view because if the Fed does two rate hikes this year and maybe if they go ahead and do some more in 2018, it’s a stark deviation from what the Fed rate has been over the past five, seven or 10 years?
The Fed is probably coming around to accepting a lower neutral Fed funds target rate than has been the case in the past. So people who talk about 3.5 percent neutral Fed funds rate, I think that’s pretty hysterical and I don’t think that is the new reality. The new reality is going to be closer to 2-2.25 percent in that 18-month and 2-year period. And so that’s what markets should be working with.
Experts tracking emerging markets have consistently said that if the U.S. 10-year yield touches 3 percent, it’s mayhem because rates will go up, and fund flows will start reversing back to the U.S. Bond and equity markets will follow suit. With an assumption of two rate hikes this year, do you think, even if these moves happen, there will not be a catastrophe of sorts for fund flows into EMs?
This is a really key point that you raised. If we look at the trajectory of the rupee and the yuan for example – the two key emerging markets – since the beginning of this year they have not weakened substantially in terms of exchange rates in relation to the U.S. dollar. In fact, they’ve actually strengthened, and the polls as of yesterday (Tuesday) still indicate that the majority of analysts expect that we will see weakening of the yuan and the rupee as we move through the rest of this year. But we’re not talking about the kind of weakening associated with destabilising capital outflow in favour of an emboldened U.S. and U.S. capital markets.
So you’re right at this place. A script in messaging is very important and Janet Yellen is very aware of that. We’re not going to see the taper tantrum and the like replayed as we’ve seen previously. And I don’t think we are going to see those destabilising capital outflows for the emerging markets.
Your thoughts on India?
I think India’s done well. The reform process is continuing. Domestic demand is reasonably healthy. The problem we’ve got now is the price of crude relative to moves in the U.S. dollar and the rupee. It’s a key factor in the current account deficit, so that will have to play out. But I think in relation to India being a good investment opportunity, that is still there.
Even though the growth trajectory in China has recently stabilised, I think the issues with North Korea and China’s broader role in the region is leaving a lot of people nervous about what may occur, particularly in the event of financial sanctions against North Korea and also Chinese banks. That would have that ripple effect, just as it did with the Russian banks when the sanctions hit them.
If you’re looking at markets across the next 12 or 18 months, would it be the U.S. and the developed markets, or would you believe that emerging markets hold centre stage, or do you believe there’s enough liquidity for everyone to benefit?
I think there’s got to be enough liquidity. We’ve got to remember that an enormous amount of liquidity has been pumped in in the aftermath of the global financial crisis, and we’re not going to remove it in a panicked way. That seems to be quite clear from the Fed’s action to date.
I don’t think the rest of the developed markets are in a healthy enough state. We’ve got round 2 of the French presidential elections this Sunday, so there’s uncertainty there; major parties of both have been sidelined. We’ve got the Brexit discussions beginning next week as well.
So there’s a bit of uncertainty in other developed markets, which means that emerging markets to the extent that their fundamentals are continuing to improve, and structural reforms are occurring, are going to stand themselves in really good stead to capture a proportionate share of global flows.