Economic and Market Commentary

Where Will Fed Rate Hikes Stop in 2019?

As the policy rate path grows more uncertain, investors should take a cautious approach but seek to take advantage of new opportunities.

Visit Rise Above Rising Rates for PIMCO’s latest views on interest rates.

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Anmol Sinha: Hi, my name is Anmol Sinha, and I’m here today with my colleagues Tiffany Wilding and Jerome Schneider, and we’re here today to talk about the December Fed meeting—implications of that meeting and where we see opportunities today. Tiffany, Jerome, thank you for being here today.

Tiffany, Jerome: Thank you.

Anmol:  Tiffany, maybe we will start with you. So as we expected, and the markets expected fed raised rates for the fourth time this year, which now marks the ninth time in the cycle. What did you think were the key takeaways in terms of the statement, the press conference, and the so-called “dot plot”?

Tiffany: Yeah, well, I guess starting off I think more broadly, the recent tightening and final conditions that we’ve seen some more indicators that global growth is slowing I think just more broadly reduced or weaken the argument that the feds needs to take monetary policy into restrictive territory this cycle, and when I say restrictive territory, I mean they actually feel like they need to hike interest rates above where they see as kind of neutral.

So I think that that theme definitely came out in today’s statement and a summary of economic projections, but I think at the same time its important to sort of caveat that despite downgrades to the forecast that we saw today, the economic outlook is still above trend, and the US growth is still expected to be above trend, the unemployment rate is expected to continue to fall, if only modestly, but in that kind of environment you still need to be hiking interest rates especially when you are slightly below where you kind of think neutral is.

So today’s rate hike as you suggested brought the fed funds rate, the effective fed funds rate, slightly below where they see those neutral ranges are, so we continue to expect them to hike into neutral territory in 2019 despite the fact that we’ve seen tighter financial conditions over the last several months.

Anmol: Great, and its interesting that you talk about growth still continuing right, because it seems that there’s a little bit more of a negative tone in markets. So maybe Jerome, we can turn to markets for a second. Interesting reaction today, how would you characterize market response.

Jerome: Well it’s punctuated by uncertainty given by the marketplace,and then volatility that followed. When we initially had the announcement, basically we had a slight relief from a credit point of view and a risk point of view, but then as Powell came on stage and really started answering questions how the equity markets sold off the curve continued to flatten in the US Treasury market. And the risk off sentiments that we’ve seen sort of evolving over the past few weeks have really come together and become more profound.

So right now, the markets effectively priced out the rate hiking sequences that that not only the fed had forecasted but we here at PIMCO has forecasted into 2019 and beyond. And now from that point of view we had to really think about, from a market point of view, if that’s going to be happening, if there’s really on the verge of a potentially recessionary environment, and that brings us to implications as well. But right now, the implications are rather negative for the market place. That being said, was given, clearly as Tiffany alluded to, was a more upbeat data dependent type of scenario analysis by Powell. And that data dependency is something that the market has become increasingly unsettled with and is again punctuated by a flattening yield curve.

Anmol: So certainly a lot of discussion and debate about the future path of rate hikes, how many times will the fed be hiking in 2019, so maybe Tiffany we can come back to you. What did you glean today about the path of rate hikes in 2019 and beyond?

Tiffany: So I think first of all, one of the things we’ve been talking about for a little while now, is that as rates go into more neutral territory, the path of interest rates just naturally becomes more uncertain because you can either hike interest rates, you can stay on hold, or you could even cut. So we are getting into that area of neutral policy we saw FOMC participants the range being that we could hike even 1, 2 or 3 more times in 2019 we at PIMCO believe that 1 to 2 more times is more likely given our outlook which is for a below consensus real GDP forecast. The factors that are behind that in our view are the fact that we have seen tighter financial conditions more recently and slow and global growth as well as fiscal stimulus which should be fading next year.

Anmol: So sentiment clearly has become a little bit negative though coming into this last year fourth quarter fair to say probably the biggest characterization of it fair to say is volatility. Pretty stark difference from Q3 where we had about an 8% equity market return in the quarter, now we’re looking at a year which is going to be a negative return year for the S&P first time since 2008 really. So when we think about that and the backdrop being one where uncertainty is rising, valuation still probably elevated and volatility still rising in those markets, how should investors be thinking about opportunities in 2019?

Jerome: As we entered Q4, our analysis was basically that everything was going to be sinking lower in terms of global growth, US growth, etc. That doesn’t mean negative growth, that means still just simply positive growth in that 2-2.5% realm for the United States and that’s something that the Fed is going continue to have to push back against in terms of normalizing their monetary policy. And that’s what they concluded today. For investors, what it ultimately means is reacting to tighter financial conditions, slightly tighter liquidity conditions, and that means risk assets are going to effectively reprice but investors are going to have to be prudent in allocating risk in several different ways: one, thinking about the trajectory of rates, ultimately what does that risk-free rates mean to risk assets as it moves higher; secondly, the cost of liquidity clearly going higher so investors are going to have to be focused on the liquidity aspects of being defensive when they need to be but also the liquidly aspects of the risk assets they’re making; and finally, be more selective in actually risks so from a fixed-income portfolio analysis still be prudent in terms of the beta allocations you’re taking, there’s plenty of opportunities to be more defensive, look to the front end of the credit curve where you can find good yields in the realms of 2.5-3.5% or more in one to two year type of corporate credits if you truly want to de-risk. And finally, there’s high quality situations including agency mortgages and mortgage backed securities which offer you not only security of an asset but really coming forth and looking into having a good quality spread along the way.

Anmol: Great. Thank you Tiffany, thank you Jerome for being here and I look forward to continuing the conversation in the New Year, which may be a little more frequent, given that the press conferences will also be more frequent and thank you all for joining us today.

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