If the US Federal Reserve raises rates this week, as markets widely expect, it is unlikely to be making a significant mistake, says Western Asset Management.
In a recent update titled Fed Update: The Morning After, Western Asset Management portfolio manager John Bellows said the risks associated with the US Federal Reserve raising rates in December are “rather low” and its "far from clear that the Fed is making a mistake by hiking next week".
“The Fed’s broader stance will continue to remain accommodative, and the vulnerabilities in the financial system and real economy are much reduced,” he said.
Markets are also priced for a rate rise, so any other move by the Fed would result in unwanted volatility, Mr Bellows said.
Moreover, Mr Bellows pointed out that the Fed has been insistent on the fact that it can, and will, moderate interest rates if growth disappoints and downside risks emerge.
The decision to leave rates on hold in September marked the central bank’s willingness to act on both domestic and global downside risks.
As a result, Mr Bellows argued that the Fed is likely to continue raising rates throughout 2016.
The role that communications has played in the Fed’s decision to raise rates is likely to persist in influencing the direction of monetary policy in 2016.
“In particular, we think the communication strategy has some momentum, in the sense that now that the Fed has worked so hard to start the rate hiking cycle, it will not lightly reverse course.
“We therefore expect that the Fed will continue hiking in 2016, with at least one more hike at the March meeting before reconsidering its strategy later in the year,” he said.
Mr Bellows also expects the Fed’s medium-term outlook to remain unchanged and continue to justify further rate cuts.
“Simply put, if the continued downside surprise in core inflation and further decline in energy prices experienced through [the fourth quarter of 2015] were not enough to force the Fed to reconsider its medium-term outlook, why should anybody expect developments in [the first quarter of 2016] to be any different?
“As long as we expect the Fed to stick with its medium-term outlook at least through March, we should also expect the Fed to follow through with another hike at the March meeting,” he said.
Economists agree that the Reserve Bank is likely to remain in inflation fighting mode until December. ...