Market comment: Fed on a mission to normalise rates

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As widely expected, the US Federal Reserve decided yesterday to lift the federal funds rate by 0.25% and gave details on how it intends to reduce its balance sheet. According to ABN AMRO’s Mary Pieterse-Bloem, the Fed’s decision to hike rates in spite of low inflation shows the central bank’s willingness to steer interest rates to more normal levels.

In a well flagged move, the Federal Reserve (Fed) on Wednesday announced its second rate hike of this year, raising the target range for the federal funds rate to 1.00-1.25% (+0.25%). The Fed also said it will reduce the amount of bonds on its balance sheet by a maximum amount of USD 10 billion in the first month, increasing it to USD 70 billion over the course of 1,5 years. US bond yields actually fell last night, in a sign of disbelief that the central bank can deliver on its own forecast of rate normalisation given that inflation is so persistently low. The EUR/USD and US stocks showed a more muted response. 

Mary Pieterse-Bloem, head Fixed Income at ABN AMRO Private Banking, believes the Fed’s rate hike makes sense from an economic perspective: “Although labour data disappointed recently, the US job market in general is doing very well. We believe the recent weakness in macro data to be temporary and nothing to worry about, as does the Fed."

Inflation remains below target
In terms of inflation, the picture is less clear-cut. Pieterse-Bloem: “It could be, as our economists have pointed out, that we have entered a phase where inflation is structurally lower than in the past, due to the impact that digitalisation has on price levels in the service sector. That would explain why inflation is still below target, both in the US and Europe. So far, low inflation doesn’t seem to keep the Federal Reserve from hiking rates. We believe yesterday’s rate hike shows that the Fed remains committed to its mission – normalisation – which means it seeks to raise short-term interest rates to more normal levels.”

Corporate bonds to benefit from economic upturn 
If the Fed can deliver on its rate hike trajectory, bond yields will move higher. This could hurt bond portfolios, as bond prices move inversely to yields. “We suggest bond investors to limit the interest rate sensitivity – or duration – of their portfolios,” says Pieterse-Bloem. “The good news is that the Fed’s normalisation path is induced by economic growth. That is why we see investment opportunities in corporate bonds, specifically from companies reaping the benefits of an improving economy.”

Mary Pieterse-Bloem is interviewed by CNBC on the Fed rate hike 
Group Economics on the rise of the US interest rate