How a delay in US interest rate rises will affect schemes

Jonathan Stapleton
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The Federal Reserve has decided to put off a decision to raise US interest rates. Jonathan Stapleton looks at how this will affect schemes.

Last week, the US Federal Open Market Committee (FOMC) decided not to tighten monetary policy - leaving the Fed funds rate unchanged at 0.00-0.25%.

The committee said "recent global and economic conditions" had reduced the short run inflation outlook resulting in the Fed requiring "a little more time" to gain reasonable confidence that inflation would return to trend.

Federal Reserve chairwoman Janet Yellen developed this theme in her press conference. She stressed that the domestic US economy was "strong" and that the labour market had seen further improvement.

She also discussed downside risks of any rate rise on Chinese economic performance and highlighted the likely impact on emerging markets more generally.

Immediate financial market reaction saw two-year US government bond yields fall to 0.68% from 0.77% before the release and 0.80% earlier in the day.

Columbia Threadneedle global head of fixed income Jim Cielinski (pictured) believed the statement was "a bit more dovish than markets expected" - saying he no longer expected a rate rise in 2015.

He said: "You can rule it out for 2015. The things they talked about, the things they said made them worry are not going away over the next few months and I don't see a tightening until 2016."

But Cielinski added he believed the Fed perhaps should have made a move - noting that waiting until everything was in place before raising rates would create more volatility.

BlueBay Asset Management partner & co-head of investment grade Mark Dowding agreed the announcement was more dovish than expected. He said: "There must be a growing risk that lift-off won't now commence until 2016. In this regard, the Fed outcome should be regarded as a dovish surprise and this should be supportive of risk assets in our view.

"When looking at the global backdrop, it now seems quite feasible that the BoJ and the ECB will announce further policy easing before the Fed begins to tighten."

State Street Global Markets head of North American macro strategy Lee Ferridge added: "Now it's a waiting game again and every upcoming meeting is on the table so long as data and conditions can justify a move. However, there is no guarantee that the conditions will be satisfactory ahead of the end of 2015."

Despite this, others believed it was likely there could be a rate rise this year.

AXA Investment Managers senior economist David Page said he believed the FOMC was most likely to hike rates in December - particularly if Q3 employment cost index shows some signs of revival - but said this remained dependent on some stabilisation in the outlook for emerging and financial markets.

He said: "Fundamentally, we believe the FOMC will grow increasingly uncomfortable with unemployment so close to its long term estimate and ‘the extraordinary degree of accommodation'".

Prudential Portfolio Management Group senior economist Leila Butt agreed: "The Fed has deferred rate hikes to better assess downside risks to the US economy. We maintain our view that the Fed will raise rates in 2015, as the labour market is tight and inflation is being held back by temporary factors.

"Pushing the first rate hike further out raises the risk of the Fed having to tighten subsequently more aggressively, which could be disruptive for both the US and global economy - beginning the rate hiking cycle earlier would allow for a more gradual path of rate rises."

But the decision to hold rates will also have an impact on UK schemes - as the Fed's decision to hold rates will lower the chances of early monetary tightening in the UK, Europe and Japan.

AJ Bell investment director Russ Mould said the decision on interest rates were also important due to the impact they could have on equity markets (see chart below).

He said: "The S&P 500 has fallen in value five times in the first three months following the previous seven increases in US interest rates. This could have a knock on impact to UK markets and so investors will be following the decision with interest."

Schroders head of UK strategic solutions Mark Humphreys believes the decision will impact both liabilities and growth strategies.

He said the decision had resulted in a fall in long-term bond yields, pushing up bond and liability values.

He said: "The extent to which pension schemes are sensitive to these changes depends on the level of liability risk protection provided by their matching assets. Schemes with higher levels of liability risk protection, such as those that have implemented liability-driven investment (LDI) strategies, will be less affected by rises and falls in long-term interest rates."

But he said the move by the Fed could lead to continued equity market volatility - something that could benefit schemes with active equity portfolios.

He said: "Pension schemes which are flexible and dynamic in their growth asset strategies should be well-placed to capture the opportunities that this type of environment can provide."

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