Quick Q&A with the CEO: Where are US interest rates going?

Scott Schuberg, Rivkin CEO: I believe that the decision to raise US rates will emerge later than what the market expects, with regard to what is priced in to current US Fed Funds futures and the strength of the US dollar. While the US Federal Reserve must remain nimble due to the significant (and potentially temporary) effect that lower oil prices are having on headline (and ultimately core) CPI, on current data it would be crazy to disturb the current green-shoots economic recovery in the United States by raising rates. There are so many reasons for this:

  • A stronger US dollar – which would come from a hike – makes the US less competitive in trade, and their terms of trade are set up well now to benefit from a weaker US dollar
  • European quantitative easing is just heating up, the US and Europe are going to be competing for trade and investment dollars – not a great time to suddenly reflate the dollar
  • The US Treasury market is still attracting strong demand at ultra-low rates due to structural dynamics of investors who need them (even after the Fed stopped buying), so why ruin such a great opportunity to borrow and service debt so cheaply?
  • Further to the last point, while US debt has plateaued, it still sits at a massive US$18 trillion – as old bond issues expire and are rolled, why would the US Treasury want to see these incremental rate rises increase their cost of borrowing from such a massive base?
  • On a romantic note, a lower US dollar is great for emerging economies around the world and if the US can control risk through fiscal and regulatory measures, it would be great to see investment outflows continue as arbitrageurs borrow cheaply in the US and buy high yield assets from around the world.

I've held this view for many months, as you'll see from my morning market wraps, and I believe the market is beginning to wise up – at the time of writing, the first month where a probability of a rate hike significantly exceeds 50% (according to Fed Funds futures prices) is December. This is being pushed out further and further and this week's US Fed minutes – which show conflict among committee members about whether to hike this year or next – will have many guessing that Janet Yellen (notoriously dovish) will be in the camp that believes a rate hike is unnecessary. 

And while the US Federal Reserve and its Open Market Committee are certainly meant to be a group of independent, bi-partisan thinkers, it's a fact that some of them vote Democrat and some of them vote Republican. It is political – higher rates can't possibly do any good for the Democrats coming into a 2016 election (and the Republicans know it), and therefore Janet Yellen is probably going to have to flex her muscles on this decision. She's tough, she's a dove, and she chaired Bill Clinton's economic committee in the late '90s when he was president – she has to be in the no-hike camp. 

So many market analysts exist on the paradigm that it's wrong to have a zero interest rate economy and emergency rates have been in place for "too long," but on what basis? If anything, the Great Depression (obviously not apples-for-apples) would teach the US that restricting the flow of money when debt-to-GDP is high is a recipe for disaster – why do so many believe that now is the time for US money supply to contract? 

There are two caveat to all of this: one is that, to keep the Republicans happy and be seen to be putting a price signal on risk, the Fed will hike once in the next 6-8 months for pure symbolism. I wouldn't be surprised if this happened, but if anyone reads this as being tantamount to the beginning of a rate-hike cycle, I think they're wrong; two is if oil prices revert to their US$100 mean medium term average and headline CPI punishes central banks around the world for being dovish. But those two factors aside, I see no rate hike on the cards for 2015.

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