The US Federal Reserve will start tightening monetary conditions in December, ramping up rates by 2 per cent over the next two years, according a new analysis by global fixed income manager, PIMCO.
The paper, authored by PIMCO global strategic adviser Richard Clarida, argues that – barring an international catastrophe – the Fed was locked into a December hike.
“I doubt there is any plausibly probable data on the economy that could be released between now and December16 that could cause the Fed to punt in December and delay a rate hike until 2016,” Clarida says.
Based on an analysis of Federal Open Market Committee (FOMC) member statements on the pace of future rate rises, the PIMCO paper plots a “very gradual liftoff path rising to a historically low destination”.
“Along this path, rates rise by about 100 basis points in 2016 and by another 100 basis points in 2017,” the paper says. “This amounts to four 25 basis point hikes per year over the first two years of normalization.”
However, the PIMCO paper says market volatility could follow if the Fed adopts its historical strategy of maintaining that rate rises could occur at each of it eight annual meetings rather than following just the four that include formal press briefings.
“The Fed, I’m sure, will – as it has in the past – resist this interpretation [that rate rises will happen only at the media-inclusive meetings] and will continue to indicate that every meeting is ‘live,’ including the four meetings per year when no press conference is scheduled,” Clarida says. “But as liftoff commences the Fed may well find that there is a cost – in terms of increased market volatility and excess sensitivity to noisy data – to an every-meeting-is-live communication strategy that seeks to maintain maximum optionality.”
The PIMCO paper says the Fed could continue its recent policy of issuing “calendar-based guidance” to hose down volatility.
According to PIMCO, such an approach “works precisely because it links rate expectations to the passage of time and not to the realization of daily data releases”.
Clarida says the Fed rate hike cycle would likely continue until “well into 2018” in line with ‘new neutral’ nominal interest rates between 2-3 per cent, or between 0-1 per cent after projected inflation of about 2 per cent.
While analysis of FOMC member intentions suggest the Fed might like to eventually raise rates to 3.5 per cent, the PIMCO paper says such a scenario was doubtful.
“At PIMCO we are skeptical that over the next five years the riskless real return on cash will reach 1.5%,” the report says. “Investors will likely be able to earn 1.5% after inflation, but only by taking on duration, credit, equity or volatility risk.”