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Fed sets the pace on US rate hikes

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Federal Reserve chair Janet Yellen announced a dovish 25 basis point increase in the target rate yesterday, the first of three rate hikes expected this year.

Taking the federal funds rate from 0.75 per cent to 1 per cent – just the third increase since the financial crisis – presents a bullish case for risk assets, according to investment managers.

Fidelity International investment director Andrea Iannelli says: “With no big change today, and a gentle path ahead for Fed Funds, the short-term outlook remains bullish for risky assets, including credit, and for US Treasuries, particularly given the very skewed positioning in the latter.

“The USD, on the other hand, is likely to lose some steam as the focus shifts to the fiscal side and to other central banks.”

The dollar fell to a five-week low against the euro, a four-week low compared with the Swiss franc and a two-week low against the yen and sterling.

Treasury yields dropped by 10.7 basis points to 2.5 per cent.

Iannelli adds: “The Fed is in no rush to speed up the pace of tightening and will take it slowly from here. Two more hikes are the base case for 2017 unless there’s any major change in the macro picture, and then they will see what next year brings, with the FOMC that will look very different by then.”

M&G Investments investment director, fixed income Anthony Doyle says inflation’s five-year high of 2.7 per cent in February is a concern for the Fed, which will be “keen to ensure that inflation expectations remain well-anchored”.

He says: “We anticipate at least two more rate hikes, with a good chance of three by the end of the year dependent upon the extent of fiscal stimulus that is announced by the US government.”

He expects global corporate default rates to remain low, presenting a favourable environment for risk assets, such as investment grade and high-yield corporate bonds.

Political developments across European and the UK remain the primary risks, with US trade policy, or a delay in the implementation of US tax reform and fiscal stimulus also giving cause for concern.

Old Mutual Global Strategic Bond fund manager Nicholas Wall believes the accelerating rate of policy tightening will continue.

He says: “We believe further rate hikes are on the way – and at a faster clip than the market expects.”

Wall says the loosening of financial conditions witnessed since Donald Trump was elected President – pledging to “splurge” on infrastructure and ease financial regulation – have been tantamount to cutting interest rates.

“By some estimates, this has had the same impact as a 0.75 per cent cut to US interest rates.”

He adds: “As such, when deciding whether to tighten or loosen policy, financial conditions should play a large part in the Fed’s process.

“Failure to do so can lead to policy mistakes that inadvertently stoke a large expansion in credit and a permanent loss of economic output, relative to the medium-term trend.”

“We are not surprised, therefore, that the Fed tightened policy today and we expect more rate hikes later this year. Markets estimate about two hikes this year; as the Fed, mindful of its past errors, will probably seek to lean against the looser financial conditions, this appears too low in our view.”

The Bank of England’s Monetary Policy Committee will announce its decision on interest rates later today.

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