Despite some uncertainties, economic improvements in developed and emerging markets have supported a positive mood across both equity and fixed income this year. However, with some geopolitical risks on the horizon and historically low volatility in equities in particular, many investors are wondering whether the tide may turn. Against this backdrop, Franklin Templeton’s senior investment leaders discuss where they see opportunities and risks ahead.
by Christopher J. Molumphy, CFA, Edward D. Perks, CFA, Michael Hasenstab, Ph.D., and Steven H. Dover, CFA, Franklin Templeton Investments
Monetary Policy across the Globe
Q: In the United States, we have started to see the Federal Reserve (Fed) move up the path of interest-rate normalization, but some might argue that it’s taking longer than expected. What’s driving this and do you see a shift in the pace of policy going forward?
Chris Molumphy: We think the Fed is certainly taking longer than expected to normalize rates and longer than the Fed has operated historically. If we look back to the last tightening cycle— admittedly more than a decade ago—the Fed moved its benchmark short-term interest rate from 1% to over 5%, so a more than 4% move in roughly two years, hiking virtually at every meeting.
Looking at the current tightening cycle, the Fed started moving its benchmark rate up a year and a half ago, and today it is less than 1% higher. So it’s a considerably different situation.
A couple of things are different about this cycle. One is the pace of economic growth. US gross domestic product (GDP) has been growing at roughly 2% per year for the majority of this current cycle, and we are coming up on eight years into the growth cycle. That’s a pretty low pace of growth and different than in the past.
The other difference is inflation. Inflation has been very slow to pick up, even with unemployment currently at 4.3%. Inflation is running pretty low with both core metrics showing inflation still at sub-2%.
What’s interesting is that there is a divergence between what the Fed says it plans to do going forward and what the market believes it will actually do.
The Fed has been communicating it would tighten rates roughly three times per year over the next several years. Meanwhile, the market is projecting about two rate hikes in total this year.
Q: Thinking globally, what central bank policy shifts might we expect to see from developed markets outside of the United States?
Michael Hasenstab: What was an unprecedented experiment in terms of money printing has now become fairly normal throughout most of the developed world.
I was recently in Japan, which has faced very different problems than the United States. While the US economy has begun to normalize in the years following the global financial crisis, Japan is nowhere close to that. It can’t reach its inflation target, growth is still anemic, and policymakers have thrown all the monetary stimulus they can at the economy.
Those efforts haven’t fully succeeded in pulling Japan out of the rut it has been in for decades.
Incredibly accommodative monetary policy alone just hasn’t generated the results some politicians would like. I think probably the next shift in Japan—and this also applies to both the United States as well as Europe—is a shift to fiscal policy despite large deficits in these countries.