The September FOMC meeting ended with no action. For those hoping for some activity after some hawkish Fedspeak, this proved again to be a disappointment, but was not really a surprise for most. Three members did dissent on this lack of action—wanting a rate hike now—and the statement alluded to a rate hike being likely in the near future, after ‘further evidence of continued progress towards its objectives’. Risks were described as being roughly balanced, with overall growth picking up somewhat from earlier in the year, strong labor and household spending, but weaker business investment (more on these below).
Once a quarter, including for this meeting, released materials included additional projections for economic growth and inflation, as well as the ‘dot plot’, a graph introduced in 2012 as a way of showing anonymous FOMC member interest rate projections for the coming year and beyond. These projections have been inconsistent, as growth, inflation and rates have all fallen short of expectations. Actually, there’s been some call for the Fed to drop the dot plot, since these haven’t been very accurate, and the constant tweaks seem to be creating more confusion than they’re alleviating.
As they’ve also been prone to do, the FOMC has been using various speeches by committee members to some extent as marketing for the importance of prudent and measured Fed policy (i.e. not rushing anything), the importance of qualitative member discussion (seen in differing views, to combat those in Congress who would prefer a mathematical formula be used for interest rate policy instead of humans), and, perhaps most importantly, as a ‘policy tool’ itself to align expectations (e.g. telling the world they’ll be accommodative has some actual capital markets effect in creating accommodation). It’s been assumed by a few economists that the FOMC is not interested in rattling markets, so won’t move unless the market probability of such a move is already high and ‘priced in’, so to speak. This probability can be easily measured these days on a real time basis through Fed Funds futures markets. On the downside, this can also create the perception that markets are driving policy instead of the Fed, which is probably not a good precedent. The base case still appears to be a single rate hike this year, which would leave December, most likely, although these continue to be pushed out so often, a deferral to 2017 wouldn’t be surprising, either.
We wish we had a way of making these mandate items more interesting, but much of the narrative and themes are little changed from the prior meeting.
Economic growth: This is continuing to run at a generally lackluster pace, although we may see some improvement in Q3-Q4 from inventories, a tick upward in energy sector projects as oil prices have recovered, and other effects. Smoothing things out, growth for 2016 looks to be at a just-under-2%-or-so level. While below that of prior decades, it could be about on par with ‘potential’ growth and certainly better than that seen in other developed economies like Europe and Japan. There are areas of weakness, for sure, such as low private fixed investment/capex, which has plugged along at recession-like levels and manufacturing, which has bounced back-and-forth between expansion and contraction.
Inflation: This also remains stubbornly low (for policymakers), although most consumers and businesses have far fewer complaints about low inflation than they do slow economic growth. Headline CPI, including the volatility of energy prices, is at about +1.1% on a trailing 12-month basis, while core inflation has been running closer to target, at +2.3%. Some of the latter has been due to higher costs in healthcare services, but mostly by higher rents and real estate prices that have carried through.
Employment: This continues to be the most positive aspect of the recovery thus far, seen through the unemployment rate falling close to ‘full’ (i.e. best we can get), and other measures, such as jobless claims and job openings (JOLTs) running at very strong levels. The attention has turned to ‘How much stronger can we get from here?’ and the answer is: ‘Hard to say, but perhaps not much.’ In fact, some data, such as the Fed’s relatively new labor market indicator have begun to peak and trail off, which either could be a temporary phenomenon due to a data quirk or a more significant sign of a change in the cycle. The Fed has been hoping for signs of better wage growth, which is one of the last signs of a labor cycle, and there hasn’t been much of that happening except in a few specialized jobs—this can be related to broader inflation in a complicated cause-and-effect relationship, so some economists are wondering if it will happen at all this time. Consequently, the cycle could eventually end without major wage increases.
From an asset class standpoint, little has changed in valuations from the last Fed meeting due to such an extended stretch of low volatility (we’ve seen more after Labor Day, which is typical). Equities are near fair value or slightly elevated, based on the metrics being used, with expectations of a recovery in earnings later this year and next, as well as the continued positive impact of low interest rates. However, stocks continue to edge out fixed income in terms of forward-looking opportunities. Weaker perceived prospects in foreign markets may still continue to favor these segments from a valuation view; emerging markets have certainly benefitted this year from improved sentiment.
Bonds face many of the same challenges they’ve been dealing with for some time—low yields equate to low forward-looking expected returns—which forces investors to take on ‘yield-seeking’ behaviors such as going out further in maturity or down lower in credit quality to create performance. This has worked to a degree, in some cases quite well, but being mathematically-based as they are, there are practical limits to what one can expect from a bond portfolio without eventually taking on more and more of these risks at some point.
The attractive story of a diversified portfolio is well-worn, but could be especially meaningful during periods when a variety of asset classes have more balanced risk-return prospects. Varying performance between groups has shown this to be true over the last several quarters.