Policy Normalization: Why This Time is Different

Pacific Life Fund Advisors, August 2017


Below is the latest informational commentary from Pacific Life Fund Advisors LLC, the investment adviser to Pacific FundsSM


Ryan Smith: The Federal Reserve has taken an unprecedented series of actions stemming from the financial crisis of 2008. Now with nearly full employment and continued steady growth, the Fed has begun to raise the policy rate. But with over $2 trillion in excess reserves, this time the Fed’s approach will be different.

David Linton: To understand how the Fed’s approach will be different, we need to understand the two main differences from prior hiking cycles.

The first difference is the size of the Fed’s balance sheet. In the chart (see chart at 00:38), we can see excess reserves grow from zero to over $2.5 trillion following three rounds of quantitative easing. The Fed has not tightened monetary policy with this quantity of excess reserves since the Great Depression.

The second difference is interest paid on reserves, which the Fed did not pay before 2009. Now, by raising the policy rate, the Fed also raises the amount of interest it must pay on reserves.

In the chart (see chart at 01:06), we can see the Fed’s estimate of those payments. Currently each 1% increase in the policy rate will require $20 to $25 billion in additional payments to banks and money market funds.

And the bottom line?

The Fed estimates it will transfer over $250 billion dollars by 2022 (see chart at 01:24). This enormous transfer of money presents significant operational, legal, and political hurdles.

Ryan Smith: Based on these two differences from historical tightening cycles, we believe a key mechanism for tightening monetary policy will be reducing the size of the Fed’s balance sheet, and not just raising the policy rate. Reducing the size of its balance sheet should cause long-term interest rates to rise, but will lessen the need for the Fed to pay additional interest to banks.

As a result, investors may want to speak with their financial advisors about considering positions that reduce exposure to long-term interest rates.


DOL - Pacific Funds

Pacific Life Insurance Company is the administrator for Pacific Funds. It is not a fiduciary and therefore does not give advice or make recommendations regarding insurance or investment products.

This publication is provided by Pacific Funds. Pacific Funds refers to Pacific Funds Series Trust. This commentary reflects the views of the portfolio managers as of July 31, 2017, are based on current market conditions, and are subject to change without notice. These views represent the opinions of the portfolio managers at Pacific Life Fund Advisors, LLC (PLFA) and are presented for informational purposes only. These views should not be construed as investment advice, an endorsement of any security, mutual fund, sector, or index, the offer or sale of any investment, or to predict performance of any investment. Any forward-looking statements are not guaranteed. All materials are compiled from sources believed to be reliable, but accuracy cannot be guaranteed.

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Pacific Life Fund Advisors LLC (PLFA), a wholly owned subsidiary of Pacific Life Insurance Company, is the investment adviser to the Pacific Funds. PLFA also does business under the name Pacific Asset Management and manages certain funds under that name.

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