The November FOMC meeting was anticipated to be a minor affair, in that no actions were expected in terms of policy change, nor was there a press conference scheduled afterward. This played out exactly as such.
The formal statement reflected the status quo, with the committee describing economic activity as rising at a ‘solid rate’ (while acknowledging the hurricane disruptions). Also noted were growth in household spending as well as business fixed investment. Core inflation was described as ‘soft’, excluding the effects of gasoline price increases related to the hurricanes. All-in-all, little changed, but the assessment was generally positive, pointing to a continuation of current policy, which could likely be another rate hike in December.
Economic growth: At an annualized +3.0%, Q3 GDP actually came in stronger than consensus, considering the timing of the several devastating hurricanes. This dampened housing activity, manufacturing and energy transportation, among other areas, notably due to Houston being the fourth-largest American metro area and the density and economic importance of Florida’s housing and consumer markets. The glass-half-full view points to stronger economic growth in coming quarters as rebuilding generates ‘activity,’ which is a positive for GDP. However, other than the benefit gained from replacing old autos and inferior housing stock with updated versions, the long-term effect of natural disasters has tended to be mixed (more uncertain for more economically-challenged areas such as Puerto Rico, although upgrades to power grids and other infrastructure could provide a much-needed and longer-lasting boost).
Inflation: Inflation has normalized somewhat, due to timing effects of volatile components such as energy prices, but overall, near target—with the most recent headline CPI for Sept. coming in at +2.2% and core at +1.7% on a year-over-year basis. Fed officials remain perplexed by the lack of inflation pressures in the economy (seemingly a global phenomenon in this cycle) but other research points to a variety of issues—including mis-measurement, continued demographic shifts and technological innovation. While perhaps not responsible for substantial inflation changes, with inflation at low levels, even a quarter- or half-percent differential can be meaningful and throw a wrench in the Fed’s timing plans.
Employment: Labor markets continue to look positive. Again, despite a few temporary hurricane-related setbacks, almost all metrics are running on all cylinders, including jobless claims, unemployment, ‘underemployment’, JOLTs job openings, etc. Employment conditions have improved past ‘full’ employment, which implies future gains will be fleeting and perhaps less necessary, but also raises risks over time since the ultimate direction from peak levels becomes one-sided—down. That status could be pre-mature, but is worth watching, as is the Fed, due to comments made regarding the need for an arsenal of tools in the next recession, such as Fed Fund rate decreases and bond buying. This would be a reversal of their current upward path but reinforces the need for capacity when accommodative tools are again needed.
Probabilities for a rate hike in December remain high—over 95%, based on futures markets. Fed action beyond that remains in question, with a 50/50 chance of another move by early next summer; however, these probabilities are fickle. A slow rise in rates toward ‘normal’ levels’ has largely been baked into expectations of investors as well as likely the Fed itself, through speeches and other ‘hints’ provided inter-meeting as to not spur too many surprises. Next year, three hikes are expected overall, which implies continued economic growth and ongoing labor market strength, and continued hopes for inflation gravitating to target more consistently.
Investment markets continue to be driven by a handful of themes, the largest of which continue to be earnings growth and possibilities for tax cuts/reform later this year, or, more likely, in 2018. A lower corporate tax rate would have an impact on S&P earnings in a positive way, which has kept sentiment buoyed, but could also be a source of volatility if details are not ironed out as quickly as hoped and/or other political side issues detail the process. Foreign markets continue to show improvement, and being earlier in the business cycle than the U.S. at this point, could also demonstrate the potential for longevity. Certain risk markets have certainly become more fickle with higher valuations in many areas, but the idea of a full ‘bubble’ may be premature, as long as pricing is sustained by underlying fundamentals. Normally, September and October represent the most volatile months of the year from a seasonal standpoint, while the ‘Santa Claus’ rally has historically boosted prospects in November and December. This year, the continued low vol environment certainly bucked the trend of the former, while we have a few weeks to sort out the latter.