The inflationary pressures will continue to rise in the US throughout 2018, says an expert

By SHAHEERA AZNAM SHAH / Pic By BLOOMBERG

The US interest rate is expected to rise for the next two years following the country’s robust growth coupled with the hastened inflation and low unemployment rate, said an investment manager.

Manulife Asset Management Ltd chief investment strategist Philip Petursson said the country’s unemployment rate has been at its lowest since 2000 with 3.8%.

“The US inflation has accelerated in just about every month this year. These two reasons fall squarely at the feet of the US Federal Reserve’s (Fed) dual mandate of full employment and stable inflation.

“As expected, the Federal Open Market Committee (FOMC) raised its target benchmark interest rate and this did not come as much of a surprise to us, nor to the market.

“At the start of 2018, the infamous ‘Fed dot plots’ suggested three rate increases for 2018. But in the last few months, we expect a total of four rate increases for this year,” he said in a statement recently.

He added that FOMC’s move in raising the target benchmark implies a shift to four rate increases for the year 2018 and an additional three for 2019.

On June 13, 2018, the Fed raised the US interest rates by 25 basis points (bps) to a range of between 1.75% and 2%.

The Fed has anticipated a continued strength in the US economy with the gross domestic product to expand at 2.8% this year, while expected to weaken to 2.4% next year.

Moving forward, Petursson said the interest rate has the potential to be raised despite the Fed signalling its confidence to a tolerable target inflation above 2% until 2020.

“For the first time since the financial crisis, the Fed funds rate is above the preferred measure of inflation of core personal consumption expenditure, which registered at 1.8% in April 2018.

“Although the Fed signalled that it would tolerate a target inflation above 2% at least through 2020, that does not mean that it would not be raising the rates along the way,” he said.

He added that the inflationary pressures will continue to rise in the US throughout 2018 as seem to be moving on an upward trajectory since June 2017.

According to Petursson, the tight labour market and aggressive fiscal expansion are among the top factors that have aggravated the upward inflation trend.

“Further supporting higher inflation, US President Donald Trump recently signed into fiscal stimulus policies, including the US$1.5 trillion (RM6 trillion) in tax cuts and a US$1.3 trillion spending package. “Aggressive fiscal expansion at this

point in the business cycle is ‘highly unusual’ and bolsters concerns. The unemployment rate is seen falling to 3.6% in 2019 compared to 3.8% today,” he said.

Petursson said the asset manager anticipates the US 10-year Treasury yield will resume its upward trend to 3.25%, while higher inflation and interest rates continue to climb.

“The Fed will continue to push up the short end of the yield curve by another 50 bps in 2018 and by 75 bps in 2019.

“As a result of these forces, we expect the yield curve to continue to flatten and fixed-income returns to be much more muted than in the past few years,” he said.

He said within the equity market, the rising inflation and interest rates are expected to compress the price-to- earnings of multiple of US stocks.

“The rising rates will be less of a headwind to portfolio returns, but a headwind nonetheless.

“We expect the US equities to deliver a positive return over the next year due to the strong earnings growth,” he said.

Petursson said the continuous raising rate signals a moving economy for the US, with a stable and growing pace, while driving inflation higher and reducing the unemployment rate.

“The fact that the Fed is raising rates at all speaks volumes. We (the US) are not at the stage that warrants the Fed to rein in inflation,” he said.