Going into 2016, some may question whether the U.S. Fed will stick to hiking interest rates during a federal election year—on November 8, 2016, U.S. voters will choose a new president because President Barack Obama can’t run for a third term.
However, “the election shouldn’t be an impediment to the Fed raising interest rates, especially because four out of the five past tightening cycles (going back to 1983) started or continued during an election year,” says Jeff Waldman, head of Global Fixed Income and managing director at CIBC Asset Management. He’s co-manager of the Renaissance Short-Term Income Fund, an underlying fund in the Renaissance Optimal Portfolios.
As a result, “I don’t think next year will be any different, and the market seems to be in agreement. The futures market for 2016 is pricing in two rate hikes of 25 basis points over the course of the year, and that’s reasonable given current conditions.”
Reaction to recent Fed decision
There are three key takeaways from the most recent Fed statement, says Waldman. Those are:
1. The Fed pointed to stronger growth in household spending and business investment, but it also highlighted slow job growth.
2. The central bank says global economic developments are less of a concern going forward, which is “an improvement, in terms of [those trends] not having a drag on U.S. growth,” says Waldman. Read: Offer global perspective on bond yields
3. The Fed hinted at the possibility of an interest rate hike at its next meeting, which is the first time it has offered such guidance in seven years. “It put the market on standby, provided that certain conditions are met.”
But there are additional factors that markets have ignored, says Waldman. He suggests it’s important that investors consider the impact of the recent U.S. budget deal on the Fed’s rate outlook. “Two things that [haven’t been] mentioned are related to the recent budget deal, and these gave the Fed the ability to put the market on notice.”
He explains, “The budget deal in Congress ended the threat of a government shutdown, and put an increase to the debt ceiling, which will allow [the government] to avoid a default. I’m sure the Fed is glad to see these [issues] out of the picture, since it can now focus on factors that are more relevant in terms of setting monetary policy.”
So, will the Fed hike in December? Even though markets are pricing that in, says Waldman, “The Fed [has] left them themselves a lot of wiggle room to stand pat in December. It specifically said that employment, inflation, international and financial conditions will need to improve between now and its next meeting.”
Further, “This Fed is notorious for changing the goal posts for raising interest rates. If you remember, after the financial crisis, the unemployment rate was around 10% and [the Fed] said that it would hike from zero when the unemployment rate fell to 7%, and they didn’t.” Then, he notes, they set the target to 6.5% and then well below that level, and they didn’t hike rates again.
And, “when chairman Janet Yellen took over from Bernanke,” says Waldman, “she went from being calendar-dependent on when she would hike rates to data-dependent. That’s how we got to where we are today. We’re still talking about the first Fed hike since 2006, even though the recession ended in 2009.”
Overall, he finds “there’s too much emphasis on the timing of the first hike. We expect this tightening cycle to be much more gradual when it does begin, given the debt overall and the slow economic growth that we see globally.”