It's way too soon to panic about Fed rate hikes

Friday’s strong jobs report gave the Federal Reserve the final clearance it needs to raise interest rates at its March meeting.

The economy added 235,000 jobs, beating the forecast for 200,000 jobs.

A month ago, markets saw a rate hike as a low probability, just 28%. The odds are now 100%, according to Bloomberg’s world interest rate probability.

The Fed’s move is for all the right reasons, amid some rumbles of higher borrowing costs and taking away the stock market’s proverbial punch bowl, according to Keith Wade, chief economist and strategist at Schroders, which has $US487 billion in assets under management.

Business Insider spoke to Wade about what he’s expecting from the Fed next week.

This interview was edited for length and clarity.

Akin Oyedele: There’s this idea of higher rates taking the punch bowl away from markets. In the stock market, by most measures, things are overvalued especially since the extra leg up of the Trump rally. Is that a risk on your radar, the idea that the Fed could take the punch bowl away at time when there are already concerns about valuations?

Keith Wade: It is a concern and certainly, a lot of the work we’ve done on interest rate cycles and the market shows that once the Fed starts [hiking,] investors start being a bit more wary about valuation.

This period of tightening is very much related, I think, to an acknowledgment that the economy is improving. The time to worry is really when tightening is to try and bring down inflation. From what we’re looking at, we don’t see a big deterioration in inflation expectations.

So, the time for the market to worry will be maybe later on when we do see wages accelerate a bit more. That will be more concerning for the market because that would be a different type of tightening. It will be much more like ‘this is not just a benign recognising that things are getting better, this is a need to slow the economy to bring inflation under control and cool things down.’

Oyedele: After Wednesday, the focus shifts to the pace of rate hikes. What kind of guidance are you looking out for from the Fed?

KeithwSchrodersKeith Wade

Wade: The most interesting quote from Janet Yellen last Friday was about the pace of tightening.

[Yellen said, “Given how close we are to meeting our statutory goals, and in the absence of new developments that might materially worsen the economic outlook, the process of scaling back accommodation likely will not be as slow as it was in 2015 and 2016.”]

If you go with the dots, you could get a couple of more rate rises after next Wednesday.

Obviously, there’s a lot of uncertainty at the moment about fiscal policy. Given where the economy is at the moment, you can probably justify a little bit more in terms of rate increases. They will present it very much as a normalization of the economy. The economy is getting back to normal, and rates aren’t going to go up rapidly or to a very high level. They won’t say much more beyond that because they’re still waiting on the fiscal side.

Oyedele: Is it problematic at all that they’re seeing this many hikes, partly in response to some of the fiscal policy that’s expected but hasn’t yet actualized?

Wade: As far as the Fed is concerned, the thing that’s tended to hold them back on rate rises in the past has been concern over the market reaction. That’s something that seemed to be quite well behaved in the last week or two when expectations of a rate rise really stepped up. They would have to obviously see how the market takes what they put out next Wednesday.

But if there was a very adverse market reaction, they would be concerned that maybe they’re pushing on tightening a bit too much. So far, markets seem to have taken it all in their stride — not just US markets but global markets, emerging markets, the dollar, and so on. Everything has been quite well behaved and I think the Fed will take a lot of comfort from that.

If we don’t see much in the way of fiscal stimulus, would that mean that they maybe tightened a little bit too early? No. Real interest rates are so low that they have the scope to do this as long as the economy is meeting its objectives.

The real concern for them — and the concern that I have — is that one or two signs of the consumer are slowing down. Within the detail of the payrolls on Friday, there was quite a big fall off in retail employment, which could relate to the slowdown in retail sales that we saw in January. We’ve been arguing in our own reports, forecasts, and meetings that the rise in inflation is going to trim the consumer quite a bit. If that’s coming through already, the Fed might suddenly find itself moving rates up.

Given the starting point, they will be pretty happy, actually, to be moving rates up at this stage.

NOW WATCH: This behaviour could kill your chances in a Goldman Sachs interview

Business Insider Emails & Alerts

Site highlights each day to your inbox.

Follow Business Insider Australia on Facebook, Twitter, LinkedIn, and Instagram.