The US Federal Reserve hiked interest rates by 25 basis points in September, which wasn’t a big surprise in itself. It does, however, raise questions as to how aggressive the Federal Reserve’s monetary policy tightening will be over the next 12-18 months.
US monetary policy has implications for economic growth and also for asset prices, both in the US and globally.
The US Fed has a dual mandate; they have to keep inflation under control but also try and keep economic growth on target. This is a fine line to toe, and is one Central Banks can stumble over.
If you think back to 2001 and 2008/09 recessions, the economies started shrinking after a period of tightening monetary policy. Quite where the responsibility lay is up for debate, of course, but it seems clear that interest rates and rising interest rates had a role to play.
Today, we’ve seen the Fed hike interest rates from basically zero to around 2.25%. There hasn’t been an impact of US economic growth from this tightening cycle yet. In fact, at the last meeting, the Fed raised its expectations for GDP growth for the US.
The US mortgage market has started to show signs of impact, however. Mortgage rates have gone up in the US and we’ve seen signs of slower home sales, perhaps as a result.
The impact of US monetary policy on portfolios
The fate of the US economy is an important consideration for the Moneyfarm portfolios. So far, we’ve taken the view that the Fed will be very cautious about how quickly it raises interest rates. It will probably prefer to let the economy grow a little bit faster than risk choking off its growth too soon.
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What impact will the Italian budget have on European financial markets?
The Italian Budget has been in the news over the last couple of weeks, and it caused some consternation when first announced. The government put forward a proposal that called for a higher budget deficit than maybe some market participants had expected. The danger here is really around Italy’s debt/GDP ratio, which is already pretty high.
The Ministry of the Economy has just released its underlying forecasts, so we can see if the devil is in the details.
The most immediate punchline is that the coalition is more optimistic about growth than most other people. Economic activity matters for revenue assumptions. If you’re wrong on your GDP growth assumption, you’re likely to miss your revenue targets. All else equal, that should increase your deficit.
Now, in fairness to the government, all else isn’t equal. Historically, government spending has also been correlated to GDP growth. It’s not clear if that will be true in the future, particularly if the government is less focused on managing the government debt to GDP ratio than some of its predecessors.
There’s also an important distinction between nominal and real GDP growth. The gap between the government and market consensus continues to grow to a full 1% difference in 2020, which is quite meaningful.
The coalition believes that its legislative agenda can significantly accelerate growth from an, admittedly rather low, baseline scenario and as a result its growth assumptions are fairly rosy – and well ahead of where other forecasters are.
Overall, we aren’t expecting the debate around the Italian budget to translate into a broader European problem, but it is something we’ll continue to keep an eye on.