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Richard Flax: Why December’s US interest rate decision is significant

It might seem like we’re hurtling towards 2019 at great speed, but there’s still at least one more significant monetary policy event in the calendar – the US Fed interest rate announcement on 19 December. Fed meetings can be a big deal, and we think this one might be more significant than usual.

Economic growth in the US remains robust overall, with the labour market particularly strong. But there are some signs that higher interest rates in the US are beginning to have an impact in certain segments, notably mortgages. This has raised some questions about the path for Fed policy into 2019.

And then there’s the equity market – which experienced some volatility in October. The question here is how policy makers translate that volatility and then react to it.

Equity markets might be forward looking, but they aren’t always accurate and can be especially fickle. Although the Fed’s mandate doesn’t include managing the equity market, you might argue that’s what they’ve been doing for the past decade – and maybe now they’re stepping back.

Will the Fed raise interest rates in December 2018?

Currently, the market is expecting the Fed to hike rates by 25 basis points in December. These expectations have steadily risen over the last year to above 80% in September. It’s since unwound slightly to around 75%.

Some investors, analysts and Central Bankers have called for a halt to the Fed’s rate hike programme in the wake of October’s market volatility. President Trump already made his feelings known, along with a rather more measured Fed governor Neel Kashkari of Minneapolis.

But Fed Chair Jay Powell has so far signalled that he’ll still push for another rate hike in December, effectively arguing that a strong economy and robust labour market should trump any short-term equity market volatility.

What will happen to US monetary policy?

The Fed is expected to hike in December – unless the economic data between now and then shows a significant slowdown, or there is a significant shift in equity market sentiment.

Powell could decide to manage down expectations for rate hikes of 25-50 basis points in 2019, which would give investors some assurance that they’re not adopting an aggressive policy that will continue on blindly.

One other variable to bear in mind is the state of the global economy. If European growth continues to disappoint, the Fed might consider the broader impact further tightening could have outside the US. That’s not strictly in its mandate, but the President probably wouldn’t complain.

What does that mean for markets?

If the Fed decides against a rate hike next month, or even a change in market expectations of the probability of a rate hike, will cause equity markets to rally.

Even if the Fed decides to hike rates this time, but then drops its expectations for future rate hikes (dovish sentiment), this sentiment is also likely to cause equities to rally.

However, a rate hike and a commitment to continue its aggressive monetary policy programme could cause equities to sell off.

Our view is that policy makers will probably get it just about right. Hike rates enough so that inflation doesn’t get out of control, but still keep economic growth relatively decent.

So the question is, should Moneyfarm be buying equities?

Whilst we may see a short-term rally off the back of dovish commentary or unchanged rates, we don’t believe taking on more risk is the answer over the next 12 months.

Our cautious approach doesn’t mean we aren’t monitoring the markets and your portfolios closely. We keep updating our view as the global political backdrop and economy evolves, and then adjusting our portfolios to reflect this.

Investing during periods of uncertainty can be unnerving, but it’s crucial that you put your money in a portfolio that’s built to reflect you and your appetite for risk. By doing this, you can ensure you’re putting yourself in the best position to grow your money over the long-term.

At Moneyfarm, we provide cost-efficient investment advice on our portfolios that our fully-managed by our experienced investment team. To talk to one of our Investment Consultants about how we could help you, get in touch.

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