Bob Browne, Chicago-based CIO at Northern Trust, with $846 billion of assets under management, says the US Federal Reserve is not going to raise its policy rate, the federal funds rate, any time soon.
Speaking to an audience of regional asset owners at AsianInvestor's Southeast Asia institutional investment forum in Singapore last week, Browne said, “When you have your next investment policy committee meeting, write this on the whiteboard three times: The Fed, the ECB and the BoJ won’t raise interest rates for years.”
He argues the events of this year, when the Fed almost initiated a tapering of its asset-purchasing programme amid turmoil in global financial markets, have made it even more cautious. “The Fed was spooked by the elasticity of mortgage markets and interest rates.”
He thinks the Fed erred by not meeting market expectations for at least a modest tapering, but the outcome means it is more likely to keep monetary policy very accommodative.
Although the market consensus is that it will begin to decelerate asset purchases in 2014, possibly in March, Browne thinks it will combine this with other, short-term measures of a stimulative nature. For example, it could let its Treasury holdings run off while continuing to buy mortgages.
“The Fed may not be able to repeat ‘Operation Twist’ [when it swapped short-term Treasuries for 10-year and longer duration instruments] but it could concentrate its new purchases in, say, three-to-five year maturity mortgage securities,” Browne suggests.
He also expects the Fed to redouble its efforts at ‘forward guidance’, by affirming to the market that it will not raise policy rates. “Forward guidance is material,” Browne says. “As an investor, waking up and knowing that a fed funds rate hike is not on the horizon for a few years takes away risk.”
He acknowledges earlier this year the market consensus was that tapering would be accompanied by interest rate rises, because the Fed is concerned about expectations of quantitative easing becoming permanent. Of course market beliefs also affect interest rates, but Browne is sceptical that the central bank will use overnight policy rates or other administrative tools to tighten monetary conditions.
He doesn’t see tapering that involves less buying of Treasuries as having a market impact either. The Treasury market is far too big and the Fed’s purchases relatively small. The Fed can safely stop buying these and let existing Treasury holdings mature without putting the US economic recovery at risk. Its impact is considerable in the mortgage market, however, and this is really where the Fed wants to see interest rates remain low.
That implies that when it does cut back on asset purchases, emerging market FX and equity markets should not be so violently impacted as they were in the summer of 2013. Market reactions will be more determined by local conditions.
Browne says the idea of a ‘great rotation’ out of bonds and into equities is therefore unlikely. “What we see is a great rotation out of cash, into everything,” he says, as the Fed continues to force people out of savings and into investments. While at some point in the next few years, the Fed must change its tune, Browne warns: “Don’t be too early on that trade.”