Beware the Fed's starting pistol

The world has witnessed ultra-easy conventional and unconventional monetary policy since the GFC, but three years ago it reached a point where that policy gradually needed to be removed. But this reversal, which had managed to elevate prices across a whole range of asset classes, became too much for markets in 2018 and resulted in a softening of prices across everything from equities and property prices, to high-yield credit.

But as Jay Sivapalan from Janus Henderson points out, the gradual normalisation of monetary policy was always going to experience a few hiccups along the way, and the Federal Reserve's mid-cycle pause in 2019 is just one such example.

Watch this exclusive video to hear why Jay thinks that once we get past this US-led false start in the global economy, the world will be able to return to some semblance of normalisation in cash rates and why managing interest-rate risk will be crucial.

Transcript

When we reflect back on the last 20, 30, 40 years and the developments that led to the GFC, it was essentially a significant build up in debt across the globe. Of course, since the GFC, we've had ultra-easy monetary policy both conventional; in other words, cash rates, low cash rates; as well as unconventional, quantitative easing, applied to a whole range of economies.

And we reached an inflexion point about three years ago when that ultra-easy monetary policy was no longer necessary and gradually needed to be removed. Now, of course, that's not the same across all economies, and the U.S. is at the forefront of that.

But if we reflect back on what occurred during that period, the ultra-easy monetary policy did elevate asset prices in a whole range of areas, equities, property, infrastructure valuation, and in the case of fixed interest, credit valuation and high-yield credit, in particular.

So, of course, the Fed was on this gradual path, and we've been of this view that the Fed and other central banks over the next five to 10 years will gradually remove some of that ultra-easy monetary policy. They've been on this path to normalising.

And, of course, we got to a period late last year where that was a bit too much for markets, especially around valuations, and the feedback loop was a softening in equity prices, a softening in property prices and a softening in investment-grade credit and high-yield markets. So the Fed has paused essentially for this year, and our expectation is that over the next few years that will gradually resume.

Now, we've always said that this normalising of cash rates and monetary policy, whether it's conventional or unconventional, is going to have a few hiccups along the way, a few false starts, and I think 2019 is very much one of those false starts.

Our expectation is that once we get past this mid-cycle pause in the global economy led by the U.S., we'll be able to get back to some sort of normalising in cash rates. I think it is important to frame this in the context of where normal cash rates are around the world, and we will say because of the build-up in debt that normal cash rates going forward will be materially lower than they were in the past.

So when we think about central bank policy, and let's talk about the U.S. for a moment, we think that neutral cash rates is around 2.5 for the U.S., so quite a lot lower than it was pre-GFC. And in economies like Australia, it may even be a little bit lower than that, maybe in the low twos. So, we're not talking about a very threatening environment in terms of significant rate rises around the world.

Of course, bond yields can overshoot to the upside just like they overshoot to the downside. So, our focus is more around managing the interest rate risk when bond markets overshoot with bond yields now at hundred-year lows again.

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