Having sailed through a large part of the year under a cloud of heightened economic uncertainty, investors can now take some comfort from the signals given out by the Federal Reserve that the US economic expansion remains intact.
Defying US President Donald Trump’s persistent demand to cut the benchmark interest rate further, the central bank’s chair Jerome Powell said on Wednesday (November 14) that it has no imminent plan to do so. The Fed has already made three reductions this year, having lowered policy rates by 75 basis points to its current range of 1.5% to 1.75%.
For institutional investors, the Fed’s outlook of moderate growth, a strong labour market, and stable inflation, should be reassuring as it suggests that the major risks to the world's biggest economy are largely contained. By extension, given the way US macro trends still tend to dictate investor sentiment and capital flows more generally, that's good news for the remaining global economy too.
“The Fed is talking about not cutting interest rates or not raising interest rates. I think we will just look at it from a general point of view and say that it is comfortable with the status quo and there isn't any real crisis going on at the moment,” veteran markets commentator Mark Tinker, founder of Market Thinking, told AsianInvestor.
But given that the central bank’s role is pivotal in maintaining the integrity of the US economy, Tinker said that it is “certainly not stimulating the bond market.”
“Their long-term goal is to try to deleverage the US financial system without blowing it up, and that's the real challenge in the medium term, but right now, they are not going to stimulate,” he said, “We can broadly take it as a positive thing.” But he added that challenges such as the upcoming US election in November 2020 and US-China trade tensions remain.
Indeed, the market has responded recently to the general bullish sentiment by increasing allocations towards value stocks. According to Bank of America Merrill Lynch’s monthly fund manager survey, allocations to global equities jumped by 20 percentage points month-on-month to a year-high net 21% overweight, while cash levels fell from 5% in October to 4.2% in November.
As of September end, US public pension plans held the highest level of US equities since 2007 – a median 47.3% of their assets were allocated to these investments, according to database Wilshire Trust Universe Comparison Services.
Bringing an end to the rate-cutting exercise will also give Asian countries some breathing room to pause their monetary easing, potentially stopping bond yields from sliding further.
“My call is that more Fed cuts are bound to start hurting Asia,” said Alicia Garcia-Herrero, chief economist for Asia Pacific at Natixis.
“This is especially true for North Asia, and well beyond Japan where the Fed is pushing rates into further negative territory,” she told AsianInvestor.
That said, the marginal benefits of more conventional US monetary easing would be insignificant with interest rates already at depressed levels, experts said.
“There is also a lag between monetary policy and the effects on the US economy, and if you take all of the factors [such as whether it’s priced in and the transmission mechanism] into account, the impact of another 25 basis point rate cut is actually quite small,” said Singapore-based Pierre Chartres, a fixed income investment director at M&G Investments.
Examples of the diminishing impact of looser monetary policy can also be found in Europe and Japan, whose economies continue to struggle. Their interest rates now stand at minus 0.5% and minus 0.1%, respectively.
“In those areas, the transmission mechanism is maybe not broken but severely impaired between looser monetary policy and economic growth because central banks have really done wave after wave of quantitative easing, and every time the impact diminishes a little,” he said.
While the US might not have reached that point, cutting rates is merely a small part of the bank’s overall management regime, which it has broadened over the years from boosting employment to maintaining price stability, then to governing loan supply and growth.
“Does the Fed matter? And if so, in what way?” Peter Ryan-Kane, founder of PeRK Advisory, asked rhetorically, arguing that interest rate levels now matter less than they did years ago.
“Perhaps it could be thought of a symptomatic of broader conditions, but it's no longer the potent force it once was,” he said.