Fed Note

Fed Note:

Fed policy remains at the center of investment market focus, but the October meeting wasn’t expected to be a blockbuster one.  It didn’t disappoint, as there were no changes, but did leave December open as a possibility.

The FOMC calendar was designed with eight formal meetings this year, half of which feature a press conference afterward—so about one press event per quarter.  Major announcements and changes in policy aren’t expected in non-press conference months due to the high need for communication fine-tuning, avoidance of misunderstandings/misinterpretations and a proactive setting of future expectations.  No doubt, any rate hike would be coupled with extremely accommodative language and tone describing the intended slow and gradual path for any future hikes—at least based on recent economic data and comments from officials.

The FOMC statement acknowledged some deceleration in economic metrics over the past month or so (much of which we’ve reported on via manufacturing surveys and the like)—this is usually taken as dovish by economists, since it perpetuates the need to keep easing intact for a longer period of time.

What now?  Some theorists claim the Fed would like to wait until the futures-implied probability of Fed Funds movement rises well above 50%.  So far, the chances of a December 2015 hike are far below that (under a third), but the Fed’s statement discussed that the appropriateness of a rate change will be assessed at the ‘next meeting’ specifically.  (Then again, the appropriateness of rate policy is really assessed at every meeting.)  Why wait?  In such a carefully-calibrated environment as we’ve had recently in terms of policy expectations, the FOMC appears to prefer an ‘obvious’ move, rather than a ‘surprise’ shift that could possibly rattle stock and bond markets.  While openness is seen as preferable to the mysterious FOMC policy discussions of yesteryear, it’s certainly possible the Fed has made things more difficult on itself somewhat with all thitransparency and extra communication.

How the key metrics look:

Economic growth:  There has certainly been a loss of momentum in the past quarter, following a bounceback in Q2, especially in manufacturing.  With advance GDP figures coming out in a few days, early estimates are in the 1.5-2.0% range.  This isn’t considered robust by any means, but continues to appear at the same trajectory of the slow, steady path of recent years.  In relative terms, though, it’s better than growth seen in Europe or Japan.

Inflation:  Energy prices continue to hold down headline inflation to nearly zero, while core prices have inched a bit higher to just under 2%.  Overall, with the oil price drop dominating the trailing period, weak commodity prices overall and strong dollar, inflationary pressures remain quite muted.  While the Fed would like to see higher levels, as a byproduct of better growth, including some wage pressures (which have only been seen in a few areas), this hasn’t happened en masse yet.

Employment:  Unemployment rates have fallen to the point where they could arguably be at near ‘full’ employment—the theoretical long-term ideal place that’s difficult to improve upon significantly at the margin.  One sticking point here is labor force participation rates, which have continued to fall (and are expected to fall further in coming years) as Baby Boomers retire in greater numbers, but also from impacts in disability adjustments and millennials, who have made the choice to stay out of the workforce in some cases (really).  

Market-wise, this is a volatile time of year, yet Q4 has also been the best-returning historically for risk assets due to the famous ‘Santa Claus’ rally tendency.  After the recent correction, equity assets remain at a bit below fair value in the U.S., and even more so abroad with implicit and explicit central bank stimulus efforts in effect to get global growth moving in the right direction. While the dollar’s strength has been a challenge for U.S. investors and companies, opportunities abroad remain compelling and if that dollar trend begins to reverse (it’s already flattened somewhat), it could represent a tailwind for non-U.S. assets.


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