The Fed is confident in the economy now, but by next year it may have to slow interest rate hikes and stop paring back its balance sheet, according to Rick Rieder, BlackRock's chief investment officer for fixed income.
The Fed held rates steady this week and tweaked its language on the economy, upgrading its description of economic activity to "strong," a departure from its normal assessments since the financial crisis. Rieder said the Fed should raise interest rates in September and December, but then it will be important to see how trade tensions and other factors affect the economy.
"I think 2019 is going to be very different, and ability of the Fed to keep moving at this pace, I think, could change very significantly," Riederd said in an interview. The Fed has been reducing the amount of securities it holds on its balance sheet by not replacing the Treasurys it holds as they mature.
"I think they're going to slow down the reduction of the balance sheet sooner than people think, and they're going to slow down the pace of interest rates increases," he said, noting the rising dollar could also be a factor.
Rieder also said he is concerned about the deceleration in growth of global liquidity and what it means for economies and markets. It could also become a challenge for central banks, which are in the process of "handing off" liquidity, ultimately resulting in more volatile markets. Global central banks flooded the world with cheap money after the financial crisis, providing unprecedented liquidity, and they are now winding down those programs.
For its part, the Federal Reserve is moving rates back to a more normal level and trying to whittle away at its massive balance sheet, taking advantage of current economic strength, higher inflation and favorable market conditions.
"We are draining so much liquidity so fast with the Fed reducing its balance sheet and the Treasury issuing supply," Rieder said. "You're draining liquidity out of the system. The Fed is doing it, and the Treasury is doing it. We're doing it faster than we've ever done it before."
To fund the tax cuts and stimulus, the Treasury has said it expects to borrow $769 billion in the second half of the year, a projected 63 percent increase from 2017.
According to BlackRock, liquidity peaked in dollar terms in March at about $26.5 trillion and is now at just over $26 trillion, a decline of $497 billion.
At the same time, other central banks are stepping back slowly from their super-easy money policies. The European Central Bank plans to move away from asset purchases this year, and the Bank of Japan signaled a tweak to its target rate on the 10-year government bond.
Rieder said he does not see the Fed keeping its current pace of once-a-quarter rate hiking next year. The Fed has forecast two more hikes this year and three for next year, but the market has priced in less than two for next year. Rieder said the Fed should be close to the neutral rate by the end of this year, and that would also suggest a slower pace of rate hikes next year. The neutral rate is basically just that: It neither speeds nor slows the economy.
"I think it's trade. I think it's growth in China, and I think it's growth in emerging markets," he said. "You're pulling forward what you're doing years hence, so that's also unclear, what happens past that."
The second quarter grew at a pace of 4.1 percent, the best in nearly four years, and growth is expected to be strong in the second half. The new tax law encourages companies to invest in capital expenditures.
There is also the potential for global growth to slow down if trade conflicts heat up and trade is slowed down. "What does global growth look like? Particularly the impact it can have on things like commodities. Then when you lift the value of the dollar, and many of these [emerging economies] have tremendous funding needs, you create a much more significant risk for these countries," he said.