US interest rates - where to from here?

Steve Merlicek, IOOF Chief Investment Officer, Investments 

Despite a number of commentators expecting and predicting an increase in official US interest rates there was no change at the September US Federal Reserve (Fed) meeting. The reason given was heightened volatility and uncertainty with respect to global markets and that the prudent thing to do is to wait a bit longer.

This effectively brings into effect a third mandate – global conditions and uncertainty. The danger here is that there may always be an excuse not to increase rates, especially due to volatile conditions around the world.

As one commentator said, "if they do not move now, then when will they move and there could always be a reason not to move".

The Fed was concerned that if they did move and the situation in China got worse, then they would have a credibility issue – especially as the IMF, World Bank and Bank of International Settlements all said that they should not increase rates. Chair of the Fed, Janet Yellen did indicate though that if domestic labour conditions were strong enough, then this may eclipse global concerns.

Equity markets rallied on the Fed decision though as the day progressed they sold off. Whilst markets do not like higher interest rates they dislike uncertainty even more – and now there is continued uncertainty as to when rates will increase. Markets could also have lived with higher rates – especially as they are coming off such a low base.

The Fed has been jawboning markets (to use an Australian term) though Ms Yellen is still sticking to the line that rates will increase by the end of the year. This assumes that everything else remains equal and there is no large exogenous shock to the system.

It increasingly looks like we are in a period of the new normal or new neutral to use a PIMCO phrase. It may well be the case that until there is complete capitulation and everybody believes there will never be an increase in rates that then, and only then, will you see an increase in US interest rates.

What are the investment implications and when will US interest rates increase?

There is still a chance US rates will increase in October or December but it will be data dependent and there is now the added wild card of international conditions. In terms of investment implications continuing low US rates are positive for commodities, positive for emerging markets, negative for US bank stocks and positive for the Australian dollar – but all these effects may be marginal and eclipsed by other factors.

In the meantime markets will continue to be hostage to the Fed – or maybe the Fed will be hostage to the markets going forward.


Important
The information contained in this newsletter is provided on behalf of the IOOF group of companies and is intended for financial adviser use only. It is given in good faith and has been prepared based on information that is believed to be accurate and reliable at the time of publication. Any examples are for illustration purposes only and are based on the continuance of present laws and our interpretation of them at the time.