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Aviva Investors: why interest rate hikes will continue

Federal Reserve chief Janet Yellen is scared of not raising US interest rates while Bank of England has become subtly more hawkish.

Aviva Investors: why interest rate hikes will continue

Future US interest rate hikes are likely to be driven by the Federal Reserve’s fear of falling behind the curve - even if headline inflation is not rising significantly.

This is the view of James McAlevey, manager of the Aviva Investors Multi-Strategy Fixed Income fund, who notes the US central bank is now operating with a different agenda in comparison to the last few years.

‘It seems that the Fed is intent on continuing on the hiking cycle. That looks odd in the context of recent behaviour over the last two to three years. Let’s remember that every time they had the opportunity not to hike over the last three years, they have taken that opportunity not to hike,’ he said.

As the US labour market continues to remain buoyant, McAlevey says the Federal Reserve’s models are likely to be ‘flashing amber’, indicating that wage growth will continue to pick up while productivity remains low. Against this context, unit labour costs appear high. This shows how much output an economy receives relative to wages. In the fund manager’s opinion, this measure matters more than the headline level of wages coming through.

‘It is telling them that if they don’t continue to hike rates in a gradual fashion, they are in danger of falling behind the curve. Whether that is an appropriate response or not, we won’t actually know for many more months or many more quarters.

‘I think we are beginning to see the implications of a broadly academic and moral-driven Fed on the other side of the equation: and that is that they need to continue hiking even though daily and monthly inflation numbers don’t look that severe,’ the fund manager explained.

As unit labour costs are already high, McAlevey says they are consistent with the Federal Reserve’s core 2% personal consumption expenditures (PCE) projection.

‘So the Fed as far as it looks at the landscape is convinced they have everything in place to deliver on their inflation target. I don’t think it is just messaging, I think they really believe it. If they are wrong, we will have a policy error,’ he explained.

Yellen's dovish tone

The fund manager’s comments preceded dovish comments from Federal Reserve chair Janet Yellen (pictured) on Wednesday as part of her statement before Congress.

She said interest rates 'would not have to rise all that much further' to reach a neutral level, adding that the Federal Reserve will monitor inflation developments closely, as the pace of price rises is currently below the central bank's 2% target.

Markets initially responded positively to the prospect that US interest rates will remain lower for longer.

No UK rate rise this year

Across the Atlantic, Aviva Investors Strategic Bond  manager James Vokins does not expect to see any UK interest rate rises this year – in spite of recent speculation.

‘The Bank of England is probably the most interesting case, given the inflation and growth dynamic. On the one hand, you might think what is Andy Haldane doing in terms of talking up rate hikes? But really it is not about board members being completely split from a black and white perspective,’ Vokins said.

Although some people are calling for the stimulus that was put in place after the Brexit vote last June to be unwound, given that consumer data and foreign direct investment in the UK have been relatively strong, Vokins said pressure on consumption and wages (as a result of higher inflation) represent a significant concern.

‘I think it is unlikely that they [the Bank of England] will move, but I think it is natural that while all other central banks around the world are very subtly becoming more hawkish, the Bank of England will move as well,’ Vokins added.

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