The FOMC decided to take no action at the end of their early November meeting. With a ‘unique’ Presidential election just a few days away and no Q&A scheduled for this minor meeting anyway, nothing dramatic was expected. There were two dissenting votes for this decision, one fewer than during the September meeting.
In their official statement, the FOMC noted that the case for a rate increase has strengthened, but decided to wait for further progress towards its objectives. This includes an acknowledgement that inflation has increased further toward the committee’s objective of 2%. Similar to recent meetings, strength in the labor market and consumer spending were noted, while business fixed investment remains soft.
As to the dashboard:
Economic growth: Early GDP for Q3 came in at +2.9%, which was a little better than expected, but appeared to be more the result of one-off quirks like soybean exports than fundamentally strong factors like business spending. This has been the case for some time—hopes for better growth that have not quite taken off. Estimates for the next few years continue to be in the +2% range or so, which is in keeping with the past decade of mediocre growth.
Inflation: With the oil price plunge further in the rear view mirror, the dampening effects on inflation are rolling off. Naturally, this has pushed headline CPI higher. There are some other factors affecting (especially core) inflation here as well, including high rates of medical care/materials inflation into the +5% range (roiling ‘I told you so’ anti-Obamacare politicians) as well as home price and rental rate increases that comprise a decent proportion of the CPI calculation. That said, other segments and the overall rate continue to plod along at the 2% level, plus or minus a few tenths. Forward-looking consumer inflation expectations are also relatively low, which can play a role in any inflationary/deflationary fears feeding on themselves.
Employment: Labor remains the bright spot, with low unemployment and jobless claims. While this may not have peaked, as we’ve mentioned before, it might not be as easy to extract as strong a trend of improvements going forward.
The probabilities for a December rate hike of a quarter-percent remain now above 70%, based on recent economic data and the targeted comments of various Fed governors (who like to avoid surprises by priming the market ahead of time). Recent upward moves in interest rates along the yield curve show that market expectations have ‘taken’, so to speak, with some help from inflation rising a bit. This may diffuse some of the mixed repercussions that higher rates can bring on certain assets, such as long duration bonds, equity bond proxies (utilities and higher-dividend stocks) and secondary markets like emerging market debt, which can suffer when their higher yields become suddenly less competitive.
In the longer run, though higher rates mean that underlying conditions warrant them, and that can provide an extra boost to risk assets like stocks. We’ll likely have more on that next month assuming the rate hike occurs (if it doesn’t, we’ll probably re-hash other topics), but a rate hike generally doesn’t signify the end of a cycle; rather, it’s just the progression through the latter innings.
An ongoing issue surrounds what continued low rates might mean if the current cycle ends and we enter recession. There have been other comments made from folks like economist and former Treasury Secretary Larry Summers, and even Janet Yellen herself, speculating about the potential government purchase of equities in such a scenario. This would be akin to what Japan has been doing and would provide additional ‘ammunition’ in the event we enter another recession with rates so low that lowering them would be marginally effective. This is an interesting argument. Some economists who are prone to supporting QE-type policies think such a move would be entirely appropriate, while others, who feel that broader asset markets shouldn’t be tinkered with by central banks, don’t like the precedent, as it could be viewed as falling outside of the Fed’s official mandate. Today, interestingly, the Bank of Japan has abandoned their quest for a target of 2% inflation, essentially acknowledging that monetary policy can only go so far in promoting growth—it also takes fiscal and structural reforms. While the situation in Japan is different than in the U.S., it does bring up an important undeniable truth tha