It’s all but certain that the U.S. Federal Reserve will raise interest rates from essentially zero in the not-too-distant future. The first increase in almost a decade has been hanging out there as a possibility for so long, many market participants expect the move itself to be anticlimactic.
The Fed may raise rates by a quarter of a percentage point as soon as this week, at the conclusion of the central bank’s two-day meeting. But that’s hardly a cinch, as there is a sizable camp that expects the Fed to hold off until December, and still others see a boost as a 2016 event.
Whenever the Fed does nudge the benchmark rate higher, it will be time to look ahead.
“What they do is important, but what’s more important is how they communicate what they do,” Steven Huber, fixed income portfolio manager at T. Rowe Price, said Tuesday at a briefing in New York. “How they telegraph what they’re going to to is key.”
The rate rise may elicit an immediate ‘risk-off’ trade in the markets, but that can be balanced if the Fed statement makes clear that no subsequent moves are on the horizon, said Huber, who holds a “low-conviction” view that the Fed moves this week. Baltimore-based T. Rowe Price manages about $773 billion.
One factor that would support the notion of a rate increase this week is the recent abatement of market volatility. Over the past three weeks, the S&P 500 has made up about half of the losses incurred during the highly tumultuous period of Aug. 17-25.
Hugh McGuirk, head of municipal bonds at T. Rowe Price, noted that with potentially multiple Fed moves over the next few years, rates will remain low by historical standards for a long time. He expects “a long, slow path to a very modest terminal rate of 2%, or maybe a little higher...it’s not going to be a sharp adjustment in rates as we’ve seen in previous cycles.”
The ‘unknown unknowns’ associated with raising rates after an unprecedented period of easy money are worrisome, according to Michael Conelius, portfolio manager for emerging markets fixed income at T. Rowe Price. “It has been such a long time since they moved,” he said.
Ultimately, despite some proclamations that a rate rise will stop a still-tenuous economic recovery in its tracks, there is a disconnect between the cost of money -- essentially free -- and the demand for money, which is reasonably strong in terms of Gross Domestic Product. “The U.S. economy doesn’t justify zero percent, so why are we there?” Conelius said.
Feature image by Lasse/Kozzi