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Brian Tora: Another set back for US interest rates?

A delayed rate rise could mark the end of the dollar’s recent strength, which may well be what the Fed is hoping to engineer.


Last week found me spoilt for choice on what to opine on in the investment world. Two major events – George Osborne’s last Budget before the general election and the meeting of the Federal Open Markets Committee in the US – provided oodles of relevant material for investors. Choosing which to focus on appeared hard, except that the Budget will have been done to death by now, so glancing across the pond seems a better option.

The US market has, after all, produced a stellar performance – one enhanced for UK investors by the strength of the dollar. In part this reflects the more robust nature of the economic recovery there but the continuing uncertainties, both economic and geopolitical, that exist elsewhere in the world will have encouraged a flight to quality. The US is perceived as a safe haven in times of trouble.

Not that America is without its own set of difficulties. Judging the mood of the central bank has occupied the thoughts of many in the investment community, so last week’s statement from the FOMC was seized upon with relish. The trouble was that it did not deliver the full clarification many hoped for, though its tone was sufficiently optimistic to drive shares on Wall Street higher.

Core to the debate on when interest rates are likely to start to rise is the strength of the US economic recovery. There has been disconnect between what the Federal Reserve believes is happening and the view of the market. Last week, the gap narrowed, with expectations for economic progress being downgraded and the important word “patient” being dropped from the narrative. This delivers greater flexibility into the hands of the FOMC, making it even harder to guess when rates might rise.

The issue has been whether the first increase would be in June or September. The downgrade suggests June is looking less likely, though much will depend on the actual economic data that will emerge over coming months. The US economy is heavily dependent on the consumer, who is undoubtedly receiving a boost from the lower oil price, even if the fall that has taken place makes shale oil production less attractive and thus postpones the day when the country achieves energy self-sufficiency.

A delayed rate rise could also mark the end of the dollar’s recent strength, which may well be what the Fed is hoping to engineer. Not that the level of the dollar is as crucial as the exchange rate is in most other major developed nations. If you exclude the neighbouring countries of Mexico and Canada, US exports as a percentage of GDP comes in at less than 10 per cent. The ratio is only around 13 per cent if these countries are included. The economy there is remarkably self-sufficient.

The level of the dollar does, however, affect the earning capability of US companies, which are seeing an increasing percentage of their revenue arising abroad. Clearly this is of more concern to the major corporations over there – those bastions of capitalism that go to make up the S&P 500. This benchmark has been in new high ground recently and it is worth remembering it has trebled in value since the depths in the wake of the financial crisis of 2008.

So should the continued dovish stance of the FOMC encourage a greater commitment to US shares? Overall, the economic outlook for the coming year looks favourable but it strikes me that markets there are well up with events. Perhaps a flow of positive – but not too positive – data will see the recovery continuing, while interest rates remain low. But such a scenario cannot continue indefinitely. And we have yet to experience the consequences of unwinding quantitative easing. We need to watch US markets closely and to be prepared to be nimble.

Brian Tora is an associate with investment managers JM Finn & Co.


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