U.S. Fed finally off the couch – now what?
Sadiq S. Adatia
Chief Investment Officer
Opinions as of December 16, 2015
We have liftoff.
After holding its benchmark policy rate at essentially zero for the past seven years, the U.S. Federal Reserve has finally made a move. The rate is now a quarter point higher, with the top end of the range at 0.50%.
Here's what the central bank says about the state of the U.S. economy in today's policy statement:
"The Committee judges that there has been considerable improvement in labor market conditions this year, and it is reasonably confident that inflation will rise, over the medium term, to its 2 percent objective."
So now what?
First off, today's move was expected by most market participants, including us. The focus has shifted definitively from "When will they raise?" to "How fast will they raise and where will they stop?"
Here's another quote from the statement:
"The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run."
Projections released with the statement suggest the Fed still sees four increases next year, in line with an earlier forecast. We do see at least one additional increase, but not four.
So far the markets appear to be taking things in stride, as Fed Chair Janet Yellen has long said the first rate hike would most likely be this year. That said, we do expect bond yields to move somewhat higher.
It's important to remember that equity volatility had already picked up over the past few months with no connection to the rate situation in the U.S.
The Canadian dollar has fallen along with oil prices, but we think the rate hike will have marginal additional impact given the increase was almost fully priced in prior to the announcement.
Though some may feel that U.S. equity markets will have more difficulty, we believe the U.S. remains on solid ground, and that the equity market there continues to be a better alternative to Canada – though we still prefer international equities to both regions.
[Editor's note: If you're a financial advisor, join us January 11 at 2pm Eastern Standard time for our annual Outlook webcast, where Sadiq will dig deeper into some of these themes.]
Central bank policy around the world continues to diverge. This speaks in part to the unevenness of global economic growth as well as to a shifting currency landscape.
The Fed raised its policy rate today as a show of confidence in the U.S. economy. Meanwhile the Bank of Canada has cut rates to defend an economy struggling with the impact of low oil prices. In addition to rock-bottom rates, the European Central Bank has been expanding its easing policies. So has the Bank of Japan.
Source : Bloomberg. Data as of December 16, 2015.
Why is this important? Because different policies can have different effects on regional capital markets. The ability to thoughtfully navigate investment opportunities and risks by asset class and region becomes more critical when there is no one rising tide to "lift all boats" (or a receding tide to beach them). This is not new – we've been in this mixed policy environment for a few years. But the degree of divergence is growing more pronounced, and with it the uneven pace of global economic growth.
The bottom line is that asset class return profiles can be significantly affected by monetary policy, and when policies change and diverge, appropriate diversification becomes increasingly challenging – but also increasingly important.
This commentary contains information in summary form, for your convenience, published by Sun Life Global Investments (Canada) Inc. Although this commentary has been prepared from sources believed to be reliable, Sun Life Global Investments (Canada) Inc. cannot guarantee its accuracy or completeness and is intended to provide you with general information and should not be construed as providing specific individual financial, investment, tax, or legal advice. The views expressed are those of the author and not necessarily the opinions of Sun Life Global Investments (Canada) Inc. and/or its affiliates. Please note, any future or forward looking statements contained in this commentary are speculative in nature and cannot be relied upon. There is no guarantee that these events will occur or in the manner speculated. Please speak with your professional advisors before acting on any information contained in this commentary.
© Sun Life Global Investments (Canada) Inc., 2015. Sun Life Global Investments (Canada) Inc. is a member of the Sun Life Financial group of companies.