Time to model a Fed rate hike
How much has changed in the past 90 days?
That’s the question that confronts officials at the Federal Reserve and institutional investors everywhere ahead of March 15, when the U.S. central bank will decide whether to raise short-term interest rates for the first time since December.
Since then, an oversupply of oil, a continuing slowdown in China and the prospect of deflation across the global economy have unsettled financial markets and possibly lowered the probability of a rate hike this month.
“The balance of risks have been roughly symmetric for inflation and tilted to the downside for growth,” William Dudley, president of the New York Fed, said Monday in a speech.
Or conditions remain mostly the same since December and, if anything, the U.S. economy is strengthening, as evidenced by growth in the job market, an uptick in manufacturing orders and consumer spending, and signs that inflation may be starting to stir.
“I don’t see any signs in the data of any slackening of domestic demand,” John Williams, president of the Federal Reserve Bank of San Francisco, told the Financial Times on Tuesday.
We’ve modeled three scenarios for rate hikes
Whatever the reality may be, MSCI has tested three scenarios that describe the impact of tightening by the Fed on investment portfolios.
IMPACT OF FED RATE HIKES ON MAJOR INDEXES
As the chart above shows, the scenarios imagine, variously, that the Fed raises rates:
- Too early, too aggressive – Rate hikes occur too early and too fast, a prospect that may stall recovery and lead to incremental losses of 2 percent for stocks and gains of 7 percent for government bonds
- Too little, too late—The Fed does not raise rates quickly enough, a prospect that could lead to a falloff of as much as 7 percent in emerging-market debt
- Ideal timing – The Fed raises rates in sync with a recovery, a prospect that may lead to an additional gain of 3 percent in global stocks and modest losses in global government bonds
The analysis, which you can read in its entirety here, suggests a range of outcomes that portfolios might be exposed to, depending on what the Fed’s timing turns out to be.
Though it’s anyone’s guess how the data might influence the Fed’s thinking about the pace of rate hikes, the contrasting views of policymakers suggest that now may be time for investors to model the impact of the three scenarios on their portfolios.