US rates to head higher? Lack of Fed firepower suggests otherwise, says Kames
A lack of available firepower for the US Federal Reserve to respond to any slowdown in US GDP growth means investors should temper their expectations for rate rises at this point in the cycle, John McNeill at Kames Capital has said.
McNeill, co-manager of the Kames Absolute Return Bond Global Fund, said while the common assumption among investors is for interest rates in the US to rise substantially as the economy recovers, the reality could be very different this time around.
The current period of expansion in the US is already 90 months long – making it the third longest on record – and McNeill said given its stage of maturity, the Fed Funds Rate is unlikely to climb much further from its current level of 0.75%.
“On any historic comparison, this has been a long business cycle. Because it has been a long cycle does not mean it must end, but it is worth investigating what actions central banks may have to take to respond to any future downturn,” McNeill said.
“The Federal Reserve is still raising rates but they will not be able to raise the Fed Funds rate above 2% without provoking a significant slowdown in the economy, and in this context the risk of negative US rates would seem to be higher than the prospect of ‘normalisation’.”
In previous cycles, the Federal Reserve and other central banks had a lot more firepower when it came to cutting rates. Andrew Haldane, the Chief Economist of the Bank of England, has estimated that the “typical” monetary policy loosening cycle in the UK, US, Japan and Germany since 1970 has seen official rates cut by between 300 and 500 basis points.
Using the US as an example, McNeill explained that in the Great Financial crisis the pattern saw Fed funds fall from 5.25% to essentially zero, while it also implemented $4.5trn of quantitative easing. But with the picture so different this time around, McNeill said such a low level of rates prior to a slowdown means unconventional policies would once again have to come to the fore.
“The current 10-year US treasury yield is 2.4%, and if the current business cycle runs for another three years it will be the longest expansion ever. Despite this, the market pricing of the 10-year US treasury yield in 3 years’ time is around 3%, and it is for these reasons that we do not share the common view that government bond yields are heading materially higher.”
While it is hard to predict when a slowdown will occur, the length of the current period of growth for the US economy is such that McNeill believes investors should be looking out for lower bond yields, not materially higher ones.
“Very low government bond yields in the future seem more likely than much higher yields,” he said.