As anticipated, the Fed held off raising rates at the meeting, likely due to the uncertainty surrounding the general election, but it also laid out its case for a December hike, which we think very likely.
We did not expect yesterday’s Federal Reserve Federal Open Market Committee (FOMC) announcement to indicate a change in policy rates, coming nearly a week before a highly contested general election on November 8, but we did anticipate the Committee would continue to make its case for a rate hike, almost certainly to come next month. The language of the announcement did precisely this, repeating the phase that “the case for an increase in the federal funds rate has continued to strengthen.”
Also, we saw a second month of significant dissents to the statement (although, interestingly, Boston Fed Bank President Rosengren withdrew his dissent this meeting, but this is likely due to an interest in supporting the Chair with the knowledge that a December rate hike is likely the base case). That indicates to us that the majority of FOMC voting members would like to execute another rate hike, again probably at the December meeting, as that would be consistent with a deliberate policy rate normalization path in the context of lower than historic levels of natural interest rates (lower R*).
We also think there is a significant subtext to be found in the Fed’s recent policy stance, in that it implies that the central bank will allow inflation to run a bit hotter than it has historically (the so-called “high-pressure economy”). The Fed is likely to take this stance due to: 1) the lack of satisfaction with pre-existing inflationary expectations, 2) a potential growth/output function that is organically lower (attributable to demographic headwinds and technological disinflation), and 3) a greater set of policy tools that can be employed to bring down inflation, as opposed to those geared towards increasing it.
Finally, as we’ve mentioned previously, the utility of extraordinarily low interest rate levels has long since passed much effectiveness in stimulating real economic growth and for some time now has solely been influencing the financial economy as a price-supporting mechanism. It is extraordinary to think that the Fed last cut its policy rate in December 2008, and in the 63 FOMC policy meetings since that time, it has only moved rates once (a 25 basis point hike last December), while the economic, employment, and financial market landscape has changed markedly throughout this time.
Thus, as we have also long argued, the baton must now be transferred from monetary authorities to the fiscal channel, if we are to see any meaningful re-rating of economic growth in the U.S., and further stabilization of global growth as well. Of course, the possibility of future fiscal policy support, and even the continuation of extraordinary monetary policy, both have political elements to them, and we will therefore have more clarity on the political (fiscal) impacts to be seen in 2017 after next week’s election.
Rick Rieder, CIO of Fundamental Fixed Income at BlackRock, and co-manager of Fixed Income Global Opportunities (FIGO)