Improving US economic data and stabilization in the global economy have upped the odds that the Federal Reserve (Fed) will raise interest rates in the coming months following a long pause. Roger Bayston, senior vice president, Franklin Templeton Fixed Income Group, discusses why he thinks the Fed may now feel more comfortable increasing rates for the first time since December 2015 and explains why he thinks another rate hike this year may not mean the “lower-for-longer” trend in interest rates is over. He also provides a short overview of the US economy and reveals how he’s positioning his portfolios in the sixth year of an economic recovery.
Federal Reserve (Fed) Chair Janet Yellen recently hinted that a rise in the central bank’s benchmark interest rate could be on the way. With major US market averages hovering near all-time highs and the US economy showing modest growth, I believe the Fed has the ammunition it needs to pull the trigger and raise its short-term interest rate, likely this year.
However, I don’t think the Fed will go on a rate-raising spree in the coming months, and the “lower-for-longer” scenario will likely continue for US interest rates. Along with employment statistics, the Fed considers inflation a key factor when it decides whether to raise rates, and we don’t see any meaningful inflationary pressures building in the economy. The employment picture has improved, but it does not appear to have been accompanied by a corresponding rise in consumer prices overall. And, although some major US cities have raised their minimum wage, we think companies will find innovative ways around mandated wage increases. For example, some fast-food restaurants have already announced plans to replace some frontline counter workers with tablet computers.
We also think technology and demographic factors also will likely keep inflation under control. Across the entire tech spectrum, as technology is upgraded, consumers generally receive more services for the same price. And as the bulk of the baby-boomer generation formally retires, they will spend less money, which should also help keep a lid on inflation. While the Fed’s official inflation target is 2%—meaning a rise above this level would signal inflationary pressures—maybe it isn’t the most important factor in the rate-hike equation.
Focus on Fundamentals
Despite the likely buzz surrounding the Fed’s potential decision on rates either this month or in the last two policy meetings of the year, I doubt a modest increase of 25-basis-points would significantly affect overall US economic activity, although it could create some short-term market volatility. Focusing on the bigger-picture fundamentals, the US economy and market appear healthy enough to absorb the shock of a small tightening move.
Recent indicators point to a moderately healthy US economy. As mentioned, the labor market, especially for small businesses, appears healthy. Consumer spending rose 0.4% in July1 and housing prices climbed 1.2% in the second quarter,2 and we expect those numbers should continue to rise.
While there have been complaints in some circles about the relatively slower level of economic growth in the United States than in previous recoveries, we believe this slower pace of growth has prevented the development of some of the excesses in the economy that led to the 2008-2009 financial crisis, such as the housing bubble. With a lack of excesses, we think it’s possible the expansion may continue longer than usual.