Morningstar's "Perspectives" series features investment insights from third-party contributors. Here, Andrzej Pioch, Co-Fund Manager, L&G Multi-Index Funds likens Janet Yellen to the Lone Ranger.
The wait is almost over…or so it seems. Markets heavily favour the Fed going ahead with its first hike since mid-2006 next week. Many of you will remember the Lone Ranger, the fictional masked cowboy who fought outlaws in the US with his Native American friend Tonto. It would be easy to see Federal Reserve chairman Janet Yellen as the Lone Ranger, acting alone in pursuit of normalising global monetary policy from the abnormality that has occurred since the global financial crisis.
The Lone Ranger was so named because he was the only survivor of an ambushed group of Texas Rangers. However the customary definition of a Lone Ranger has evolved to refer to someone who works alone.
The scene is set. The dollar is back at its year to date peaks, commodities took another sharp leg down and two-year US yields climbed to their highest levels since 2010. Investors now wait for Yellen to play her part.
However, it is likely that any first step from the Fed will not be followed by other central bankers. It seems the US is embarking on that hiking trip alone, at least for now. After seven years of near-zero interest rates and three rounds of quantitative easing the rest of the developed world will likely stay behind and observe the market reaction to any Fed move.
Japan and the Eurozone have strong reasons to let the US venture out on its own. The European Central Bank has extended its easing measures beyond the bond purchasing programme announced in early January and the Bank of Japan is likely to stay on course increasing base money even further rather than decreasing it. Both economies are still too fragile to even consider raising interest rates in the current market environment.
The UK is different, having just been through 11 consecutive quarters of GDP growth, business investment expanding throughout the year, wages starting to pick up and public finances, according to the latest Autumn Statement, likely to improve over next five years.
So How Quickly Will the Bank Follow the Fed?
We believe the Bank of England will hike at a slower pace than the Fed for three key reasons:
Firstly, the UK economy is more sensitive to interest rate movements. It has a greater share of floating-rate mortgages in the residential property market. Its economy is also more open than the US, so a hit to exports from a strengthening currency hurts more.
Secondly, the UK has still some fiscal tightening to do with, unlike the US, further austerity ahead. Combining this with monetary tightening might put recovery at risk.
Finally, inflation remains low, well below the target of 2% set by the government. While recruitment difficulties have begun to push wages higher, the second order effects of the collapse in commodity prices and the strong pound should keep inflation below target for some time, giving the Bank of England time to wait and see.
So, next week Yellen could indeed become the common definition of a Lone Ranger. However, at least for the foreseeable future, Mark Carney at the Bank of England, Mario Draghi of the European Central Bank and Kuroda of the Bank of Japan are unlikely to be her Tonto.
