Fed Note

Fed Note:

The FOMC completed their September meeting, with an outcome of no interest rate policy change as expected, but there was something a little different to announce.  This was a more ‘important’ meeting, being one of the four per year that features a post-meeting press conference and Q&A session, used to clarify and fine-tune policy (which isn’t always crystal clear in the formal releases).

In the released statement, economic activity was described as having risen moderately this year, with solid job gains and low unemployment.  Additionally, household spending shows moderate expansion with business capex having ‘picked up’ in recent quarters.  Despite near-term challenges, the Fed noted that recent hurricanes are unlikely to alter the course of the broader national economy over the medium-term, aside from shorter-term inflation challenges from items such as gasoline.

The new item was the introduction of the balance sheet normalization program.  What is that?  As a backdrop, after the Fed completed the various rounds of quantitative easing years ago, where they had been actively buying treasury and agency mortgage bonds directly to keep yields low in those markets, they continued to reinvest proceeds of maturing bonds in order to keep stimulus from ‘trailing off’ too much, so to speak.  The balance sheet is now $4.5 trillion in size, far larger than historical norms.  To turn the stimulus faucet off completely and start reversing the build-up, it could require the significant selling of bonds held on its balance sheet, which could be disruptive to markets in large amounts by driving down prices and, hence, yields up.  The other option—the one they’ve chosen to use—is letting maturities ‘roll off’ gradually by capping the amount of proceeds they’ll keep reinvesting. 

This process is designed to not result in a large degree of market disruption—done by keeping the amounts limited and expectations for this normalization to be done over a long period of time, from $10 billion/month to start, and ramping this up over time.  The assumption, based on statistics from the treasury and outside managers, is about 0.25-0.50% in upward yield drift ultimately.  Today’s announcement was just the first step in a stimulus unwinding process, but it has to happen sometime.  And, with the economy looking stronger, now is as good a time as any.  Importantly, clearing space on the balance sheet could allow the Fed to again provide more stimulus down the road when we are faced with another slowdown, although, hopefully the amounts needed would be far less than during the years of the Great Recession, when stimulus spending was unprecedented.

The ‘dashboard’ of key data reflects few changes from recent meetings:

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Weekly Economic Update

Economic Update 9-18-2017

  • Key economic data for the week included a disappointing retail sales report, slightly weaker consumer sentiment, moderately higher producer and consumer inflation and slightly improved jobless claims.  As anticipated, several of these metrics appear to be affected by recent hurricane activity.
  • U.S. equities gained for the week in a variety of sectors, accompanied by a positive week in developed foreign markets, although tempered due to the negative impact of a stronger dollar.  Bonds lost ground on the investment-grade side as yields rose, with foreign bonds affected more negatively due to currency.  Commodities gained for the week, as energy prices rose sharply.

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Weekly Economic Update

Economic Update 9-12-2017

 

  • The short week ended with a temporary respite for the federal budget and debt ceiling debate, strong ISM services results, but higher jobless claims due to hurricane effects.
  • U.S. stocks stumbled a bit on the week, as did foreign stocks in local currency terms, but the latter were saved by a large decline in the U.S. dollar for the week.  Bonds experienced a positive week as yields for certain maturities fell to their lowest levels in some time.  Real estate bucked the trend and fared well, while commodities were generally flat with offsetting forces.

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Weekly Economic Update

Economic Update 9-05-2017

  • Economic news for the late summer week was focused on a revision higher in Q2 GDP results, continued expansionary manufacturing numbers, mixed housing results, and a somewhat disappointing employment report.
  • Equity markets fared positively for the week, with U.S. stocks outperforming both foreign developed and emerging.  Bonds were flattish with credit outperforming, as did emerging market debt.  Commodities saw positive returns with gains in a variety of categories, with the hurricane impact mostly affecting gasoline prices.

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Weekly Economic Update

Economic Update 8-28-2017

  • In a very light late summer week for economic data, housing statistics were generally lackluster, jobless claims remained within recent ranges, while durable goods fell, as expected.
  • Global equity markets gained for the week, upon weak volumes and political rhetoric outweighing any meaningful economic news to move the needle.  U.S. and foreign stocks both saw positive results, with emerging markets leading the way—foreign assets were boosted by a weaker dollar.  Bonds also moved a bit higher, led by high yield.  Commodities were mixed with little change in the prices for energy.

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Weekly Economic Update

Economic Update 8-21-2017

  • Economic data for the week was highlighted by mixed housing results but gains in retail sales, several strong readings from regional manufacturing surveys, and strong results for the index of leading economic indicators and jobless claims.
  • Global equity markets were mixed last week with U.S. stocks losing ground, and foreign stocks gaining slightly on net.  Bonds were little changed along with minimal movement in interest rates, while emerging market bonds fared well.  Commodities lost ground slightly with losses more concentrated in agriculture than in energy.

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Weekly Economic Update

Economic Update 8-15-2017

  • Economic data was highlighted by weakness in inflation, with the PPI and CPI both coming in lower than expected.  On the labor side, the government JOLTs job openings index and claims continued to show strength, while labor cost and productivity growth remained sub-par.
  • Global equity markets fell last week, in line with most risk assets, due to escalating geopolitical tensions with North Korea.  Government bonds, by contrast, in both the U.S. and developed foreign markets fared well that that safe haven-seeking environment, and outperformed corporates and emerging markets.  Commodities lost a bit of ground on net as oil prices fell.

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Weekly Economic Update

Economic Update 8-07-2017

  • Economic data for the week was dominated by the employment situation report, which surprised on the upside.  The ISM manufacturing and non-manufacturing indexes both declined, but remained solidly expansionary.
  • Equity markets gained globally, as did bonds to a certain degree with lower interest rates on the longer part of the yield curve.  Commodities declined slightly, despite little net change in oil prices during the week.  Overall, low volatility conditions in stock and bond markets continue.

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Weekly Economic Update

Economic Update 7-31-2017

  • In a busy week for economic data releases, the Fed meeting resulted in no action and GDP for Q2 came in largely as expected.  Durable goods orders and consumer confidence metrics came in more positively than expected, while a variety of housing data came in weaker than expected.
  • Equity markets were generally flattish in the U.S. last week, while foreign equities continued their string of gains, helped at least in small part by a weaker U.S. dollar.  Bonds were mixed but generally lower on the investment-grade side as interest rates rose.  Commodities gained along with sharply higher oil prices to end the week.

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Fed Note

The July FOMC meeting resulted in no action.  This was one of those in-between ‘minor’ meetings, with no planned press conference nor any release of economic projections, so no announcements were expected.  The official FOMC statement noted continued strength in labor markets (as opposed to last month’s comment about the pace ‘moderating’) and economic activity rising at a moderate rate, while also acknowledging inflation remaining low.  There were no dissents.

As it stands, the probability of interest rate moves for upcoming meetings in Sept. through Nov. remain quite low, while Dec. looks to be at about 50/50 at this point.  This is not including a likely announcement of balance sheet reductions of Treasury and MBS assets, which could begin in Sept. or Oct., according to current consensus (or ‘relatively soon’ in today’s statement).

 

Economic growth:  The first release of Q2 GDP is expected later this week, and is estimated to be in range of 1.5-2.5%.  So, similar to maybe slightly better than Q1, but within recent levels.  Early estimates were higher, but sporadic manufacturing numbers and weaker housing than expected have pulled these lower.  Hopes persist for fiscal stimulus eventually which could boost growth, but no magic bullet exists currently, with inputs remaining constrained. 

Inflation:  This has been the area of recent discussion, as CPI and other inflation measures have fallen further below the 2% target level once again.  Volatility in petroleum commodity prices has been one culprit, and there’s some blame shared by short-term ‘measurement’ issues such as cell phone data plans, but concerns remain over longer-term structural issues that are keeping levels depressed.  Of course, moderate economic growth coupled with reasonably low inflation are not a bad combination.  However, the Fed assumes the historical relationship between low inflation and underlying economic stagnation remains a key consideration.  (This is especially true considering that the Fed’s mandate doesn’t include making decisions based on levels of economic growth or the pre-emptive ‘popping’ of economic or asset class ‘bubbles’, as has been discussed by some academics—inflation is the only relevant decision variable included under one of the dual mandates.)  In fact, there is a group of economists (including current and former FOMC members) that believe current inflation running below target warrants no further rate hike action at this time, and, interestingly, perhaps even more accommodation.

Employment:  Labor has remained a source of strength in almost every official metric, including the unemployment rate, JOLTs, jobless claims, etc.—to the point of being near maximum employment.  Underneath the headlines, though, lies a less robust story we’ve mentioned before, including a bulk of new jobs created being at the lower services end and related lack of wage growth.  This lack of breadth has been troubling to economists and policymakers, hoping for a more traditional situation where wage growth overall accelerates in the latter innings of a business cycle.  Instead, this may be as good as it gets, as wage pressures have been relegated to select industries and regions, such as specific construction trades, for example.  The downside is that these issues are not easily solved through monetary policy, so remain out of the Fed’s sphere of influence.

 

Historically, an economic relationship called the Phillips Curve states that as labor markets tighten, wages and other inflation pressures begin to rise, in keeping with broader economic growth.  Such an environment would warrant a tightening policy by a central bank.  In the current case, though, it represents a conundrum due to the dual mandate the Fed is subjected to:  a strong labor market says ‘raise rates,’ while eroding inflation pressures indicate ‘stay put.’  Since there is no graceful method for rectifying the two forces easily, expect more speculation and ‘data dependent’ meetings, although the labor mandate seems to be winning for the time being.

From an economic standpoint, the upcoming planned balance sheet reduction is a positive, implying the economy is strong enough to tolerate such a measure.  A key component will be the message—in order to not spook bond markets that too much treasury/mortgage debt will be run off too soon, flooding the market with supply and pushing interest rates higher.  Some estimates put the interest rate effect of run-off at a half-percent or so for the coming year, with this having a cumulative effect of up to a few percent over coming years.  Due to the sheer size of the Fed’s balance sheet, this will be a long-term effort to say the least.  Then again, rates have been forecast for several years to be much higher than they are, so take estimates with a grain of salt. 

In the near term, equity markets are sanguine with earnings growth coming in stronger and interest rates relative stable.  Volatility has remained low, and is certainly related to this lack of extreme news in either direction.  Hope for fiscal policy activity has been pushed out to later this year and into 2018, including tax reform, and some sentiment is certainly tied to success in this area.  A continual reminder that investment markets look to the future and not the present, explains the strength this year in foreign markets, areas that have been cheaper and more troubled than the U.S.  Despite warnings of complacency, though, momentum can be a powerful force and can keep rallies moving higher and for longer than the naysayers predict.

 

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Weekly Economic Update

Economic Update 7-24-2017

  • Economic data for the week was mixed, with several regional manufacturing surveys showing weaker yet still expanding metrics, but strong housing starts and monthly index of broad leading indicators.
  • Equity markets gained globally, with emerging markets outperforming developed markets.  Bonds also fared well, with interest rates declining worldwide amidst dovish central bank language and weaker inflation.  Commodity indexes fell overall as oil prices declined a bit for the week, offset partially by a rise in gold.

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Weekly Economic Update

Economic Update 7-17-2017

  • Economic data for the week was highlighted by a decline in retail sales, consumer sentiment, job openings and year-over-year consumer inflation, while industrial production ticked higher.  Investors were also reassured by Fed Chair Yellen’s comments concerning a continued slow pace of monetary policy tightening.
  • Equities in the U.S. and many foreign markets experienced gains for the week, as global sentiment improved in a few areas.  Bond prices rose upon interest rates falling globally.  Commodity indexes rose on the heels of a weaker dollar and rebound in crude oil prices for the week.

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