For a more comprehensive round up of the week, listen to Stephen’s full report here.
Risk assets rose strongly last week assisted by the US Federal Reserve’s (the Fed) policy meeting that was more dovish in its comments on the outlook for US interest than the market expected. The word “patient” was removed from the statement relating to when the Fed might lift its Funds rate, but as the Fed Governor Janet Yellen said, after the meeting, that does not mean that the Fed will become impatient regarding lifting rates. At this Fed meeting the Fed’s US economic forecasts were also updated, with GDP growth forecasts and inflation forecasts over the next few years lowered a little, while the forecast unemployment rate was lowered too. The Fed implied in its forecast changes that an apparently robust labour market is not the only consideration determining when rates will rise.
While it is understandable why the outcome of the latest Fed meeting would help the US bond market to rally, the more pronounced rally in risk assets such as equities and credit is a touch puzzling. In essence, the Fed holding the Funds rate lower for longer is an admission that even the best performing developed economy in the world, the US, is still struggling to grow as well as it could. While the US is one of the few parts of the world where company earnings have been growing comparatively well, the Fed’s latest growth and inflation estimates still imply low support from US economic growth for earnings expansion and persistently low inflation hints at margin pressure on company earnings too.
Even if very low interest rates are seemingly less potent than usual to drive stronger economic growth one argument for why they are continuing to drive up share and credit markets is that they cause borrowers and savers to rethink what risks are acceptable in their borrowing behavior or in their investments. This is one of the ways in which monetary policy is supposed to work in helping to prime stronger economic activity.
In essence, however, there is paradox when interest rates have been very low, for a long time and economic activity is proving to be unusually modest in picking up in response. At what point are persistently very low interest rates a sign that global economic growth is in real trouble, that savings remain out of kilter with borrowing demand and that the best course of action for investors is to take less risk rather the more, even though the rewards for taking on more risk seem tantalizingly high?
It is not clear that the point has yet been reached where the announcement of further monetary easing by the likes of the RBA and other central banks still able to ease should be greeted as bad news for investors in risk assets, but it is worth keeping in mind what those rate cuts mean – the economy is not growing as well as it could.
The apparent extension of the period before the US Fed starts to lift its Funds rate from zero has still been greeted as good news by investors in risk assets. Arguably a firmer signal from the Fed that it was on track to start lifting the Funds rate in June would have been better news, implying that the US economy is at last growing strongly enough to cope with a slow process normalizing interest rates.