A portfolio manager discusses the Fed’s decision to stand pat on interest rates in the context of the state of the U.S. economy, risks from abroad and implications for long-term investors.
Wesley Phoa: We should expect interest rates in the U.S. to stay pretty low until we get through this current period of uncertainty. But after that, assuming the economy stays on track, they should rise like they always do in a Fed-hiking cycle. But I think the most likely case is that they settle down at a level which is still historically pretty moderate.
The U.S. economy is in pretty good shape right now: labor market’s strong, wages have started ticking up, investment has started picking up. And the reason that rates are low — and the reason that the Fed held off hiking rates — is not because there’s a change to the outlook but because the risks have gone up, particularly the risk from overseas.
For example, there’s increasing concern that the economic slowdown that we’re seeing in China might start to accelerate; that the authorities there don’t have complete control over the situation; and that, in turn, could spill over to other countries, China’s major trading partners, and in turn, affect the United States.
There are other risks out there. There’s been a sharp drop in energy prices that affects some of our big trading partners, like Canada. And there could be a flare-up in concern about the euro area again; that’s entirely possible. So there are a number of bad scenarios that folk are worried about right now that could conceivably play out, and I think it’s quite rational that markets and the Fed have been paying attention to these downside scenarios and adopting a risk-management approach. We need to see those risks either dissipate or resolve themselves before the Fed can feel comfortable hiking in a way that it plans to and before rates can rise in the way that they normally should in a healthy, expanding economy.
The Fed would like to hike rates as soon as it’s safe to do so. They’ve told us they think it’s appropriate; that the economy is in good shape to absorb a sequence of rate hikes; and, as soon as they’re comfortable that the risks from outside warrant that, then they’ll start a rate-hike cycle. They’ve also told us that it’s appropriate to hike gradually, that they don’t want to get ahead of themselves, that they certainly don’t want to be in a position to reverse course. And I think that that’s what they’ll do — that we will see a rate-hiking cycle that’s probably slower than any of the ones we’ve seen in the past.
I’d say that for a long-term investor, it doesn’t really matter when — exactly when — the Fed starts hiking rates. It doesn’t really matter what happens over the next one, two, four months. What really matters is the path that the economy takes — and the path that Fed policy takes — over the next two, three, five, 10 years. And we really try and step back from the day-to-day speculation about the date of the next Fed rate hike and think about, well, where is the economy headed in the medium to longer term, because that’s what has the most important influence on long-term investment returns and investment risk.
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Statements attributed to an individual represent the opinions of that individual as of the date published and do not necessarily reflect the opinions of Capital Group or its affiliates. This information is intended to highlight issues and not to be comprehensive or to provide advice.