The Federal Reserve isn’t going to lift interest rates anytime soon. That’s what it says, and that’s what outside observers say, given the central bank’s new commitment to what is called average inflation targeting, as well as its stated desire to minimise income inequality.
But in a new piece on financial markets from KKR, strategists led by Henry McVey, head of global macro and asset allocation, say the central bank hasn’t committed to keep financial markets bubbling up.
“The Fed is now starting to publicly remind everyone that monetary policy is intended to ‘fix’ the economy, not continually bolster financial asset prices. Hence, it has made the decision to flag ‘financial stability’ more aggressively in its mandate,” say the strategists.
The dissent by Dallas Fed President Robert Kaplan in the last Fed meeting, they say, was an important one. “Excessive risk taking and distortions in financial markets” could lead to greater fragilities, Kaplan said in an essay published this week.
“Were more Fed [officials] to adopt his viewpoint, it could quickly reduce some of the excess froth that now appears to be building up in some of the more speculative parts of the debt and equity markets,” say the KKR strategists.
The Fed has other options, besides interest rates, to tackle financial market excess. The Fed on 30 September announced it would extend restrictions on buybacks and dividends by banks. KKR highlighted bank oversight, stress tests, leveraged lending guidelines and quantitative easing scaling as options to curb excess. “This approach is new, and we believe it represents growing caution about retail trading activity, particularly in high growth sectors like technology,” say the strategists.
The KKR team is bearish on the dollar with the Fed’s commitment to being significantly accommodative for some time. Because the market anticipates Fed dovishness for some time, the central bank will have to be as well, to avoid a rerun of the infamous taper tantrum of 2013.
That warning aside, KKR said there is a “decent” environment for risk assets, given that liquidity remains ample and that yields remain low. Corporate earnings also are rebounding, as they lifted their estimates for S&P 500 earnings per share, to $125 from $115 in 2021, and to $164 from $155 for 2021. KKR lifted its S&P 500 SPX, 0.45% target to a range of 3,350 to 3,450, from 3,020 to 3,120.
The S&P 500 ended Wednesday, 30 September at 3,363.
They say the euro can reach at least $1.25, given the fact that inflation-adjusted US interest rates are negative. They also see the potential for emerging-markets currencies to rise, including the China renminbi given that US debt loads have increased even more than Chinese debt has.
They are more bullish on infrastructure, as yields have remained relatively stable compared with the collapse in bond yields.