The US Federal Reserve focused on improvements in the US labor market most of the time last year.
It hinted that a liftoff in rates would not come until inflation rose above 2 percent.
However, the turmoil in emerging markets last summer, coupled with the devaluation in the Chinese currency affected the US market.
The liftoff eventually arrived at the last Fed meeting of 2015.
It has taken around seven years for the United States to raise interest rates from almost zero.
However, there are still uncertainties over the pace of the rate hikes in coming years.
Fed officials hint at a total increase of 1 percentage point this year and the same next year, while market participants only expect a 0.5 percentage point increase this year.
In fact, an annual raise of 1 percent would be very mild if we look back in history.
The Fed has raised interest rates by around 2.5 percentage points per year in the five rate hike cycles since 1980.
Also, macroeconomic conditions can afford increases of such a degree.
Fed officials expect real economic growth to accelerate to 2.4 percent this year.
Such estimates seem quite sensible.
The oil price fell further at the end of last year.
The US Congress has passed a tax cut package under which 50 expiring tax cuts will be extended by five years and more than 20 will become permanent.
Also, Congress approved the five-year highway funding bill.
These measures will increase the federal government’s expenditure by US$80 billion in the next two years.
And the agreement to raise debt ceiling until the end of March next year will boost the economy.
Also, rate hikes will increase interest income for US consumers, and higher mortgage rates won’t hamper the recovery of the US housing market.
Hence, US economic growth is likely to reach 2.4 percent this year.
In fact, the economy has maintained an annual growth rate of 2.4 percent over the last three years, and the unemployment rate dropped 1 percentage point each year.
The unemployment rate is likely to fall to 4 percent at the end of this year, owing to a structural shift in the labor force participation rate.
However, the Fed expects the unemployment rate to drop to 4.7 percent by the last quarter of the year.
The Fed’s rate hikes are well on track, given an improving labor market and rising wages.
That would pose a threat to the debt market.
However, there will be more opportunities in the high-yield credit market in the non-energy and non-materials space given wide credit spreads and the positive economic outlook in the US.
Meanwhile, European high-yield bonds have little exposure to the energy sector, so they are less affected by the Fed’s tightening move.
This article appeared in the Hong Kong Economic Journal on Jan. 4.
Translation by Julie Zhu
[Chinese version 中文版]
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