TOM BECKET

It is now nine years since the US Federal Reserve was last able or willing to raise interest rates. Given the omnipotence of the Fed and the impact of their actions on global markets, this is clearly a major decision for markets.

The last time the Fed raised rates there was nobody to “tweet” about it, as Twitter was not publicly launched until very shortly after the last upward decision. From a personal perspective, I was trying to persuade my wife to go on a first date with me and also recovering from my trips to the group stages of the Germany World Cup (June 2006).

Our best guess is that markets have already moved to price in the first interest rate hike. Emerging markets assets have been poor, resources investments have been dire, gold has been weak and US Treasury bond yields have continued their move higher from what we believe were the ultimate lows of the last few years.

This week the US 10-year yield got back to 2.26per cent and, more tellingly, US two- years yields are at the highs of the last few years at 0.79per cent. The dollar has strengthened 20per cent (against a global basket) in the last 12 months, which reflects both a change in monetary policy and a better economic environment for the US over other parts of the world. Equity markets in the developed world have seen their valuations moderate to reflect the end of the super-ultra-easy monetary policy from the Fed. Our view is that markets are “ready” for a rate hike and the Fed will raise rates this year.

But why didn’t they this week? We believe the Federal Reserve is divided as a whole and within the minds of individuals, respectively. Certainly a cogent argument can be constructed for the Fed biting the bullet from a US perspective, backed up by the improvement in the labour market and strong US retail shares data this week from July and August (admittedly some data remains patchy); but exogenous factors have weakened the certainty we felt the Fed had back in Q2.

They are worried about the recent weakness in commodities and the impact upon medium-term inflation. However, that fear over inflation will have been trumped by nerves over China and the emerging markets and the detrimental effect upon market sentiment. Since the wobbles in markets and the clear evidence of a Chinese slowdown, the proportion of the market expecting a rates hike this month fell from 60per cent to under 30per cent, with only half of economists surveyed by Bloomberg expecting a move this week.

We feel that many markets have already moved to paint the change in monetary stance, as I outlined above. Moreover, we feel that certain markets have gone too far, particularly in the EM space. We actually consider that the Fed hike, when it comes, will serve as a relief and that many asset markets might rally on the news. Let’s be totally honest, we are all utterly “Fed up” with the whole discussion and just wish they would stop dallying around and get on with it. Moreover, the first hike decision is relatively unimportant in the context of our long term view that rate rises will be slow and the medium term peak of rates in the US and UK will be at around 2.5per cent.

Our asset allocations reflect the change ahead in monetary policy. We expect US shares and government bonds to be dull investments in the medium term and prefer markets where the recovery is still at an early stage and monetary policy is supportive. European and Japanese equities fit the bill and European credit still looks good value.

The US economy no longer deserves a zero interest rate policy. Nine years later the world has moved on; the scars from the financial crisis have healed and the US is recovering. Though admittedly England are still rubbish at football.

Tom Becket is chief investment officer at Psigma Investment Management