The May FOMC meeting ended with a unanimous vote of no action on the interest rate front, as predicted, with the fed funds rate target remaining at 1.50-1.75%. The formal statement showed little change from the March edition, with continued growth noted broadly, with one edit noting strength in business fixed investment. Inflation was upgraded as being near the Fed’s policy target, as opposed to running substantially below previously, with other risks appearing balanced following some upgrades in March.
Predictions for a June hike still remain high—as in 95% or better—according to fed funds futures markets. This would keep the pace of 3-4 hikes for 2018 intact, with the number on either side of that estimate based on accelerating or decelerating of conditions (and reflected by a relatively even split seen in the December-dated futures).
In reviewing relevant policy considerations:
Economic growth: Higher hopes for Q1 GDP stalled a bit, when the first estimate came in at +2.3%, although that was a few tenths better than expected (while room for revisions could alter the final number in the months to come). Estimates for Q2 are starting out higher, with full year 2018 estimated in the 2.5-3.0% range before falling back to 2.0-2.5% for 2019. Tax reform at the end of last year is still expected to provide a boost in the coming few years, albeit perhaps not enough of one to combat more structural forces keeping underlying economic growth contained. If one looks through the traditional lens of economic growth being a factor of labor force growth plus productivity, squeezing out high levels of growth from two constrained inputs could be challenging indeed. This is not only true in the U.S. (which has fared relatively well), but abroad in many developed nations—and even key emerging market nations. While fears of pent-up inflation and resulting higher rates appear to be a mainstream fear more recently, it is important to keep in mind the contrary case of slower growth keeping rate levels perhaps contained for a longer period of time.
Inflation: The more recent CPI report showed headline and core inflation coming in a bit higher, at +2.4% and +2.1%, respectively, with the headline boosted by higher energy prices. With levels more consistently reaching the Fed’s stated policy level target of 2%, FOMC board members have clarified their stances a bit, emphasizing the ‘symmetric target’ component as opposed to a line in the sand, as well as a willingness to let inflation run hotter than target for a period of time as appropriate to satisfy broader policy goals.
Employment: Labor continues as the bright spot in the recovery, with almost all metrics showing strength—from the official unemployment and ‘underemployment’ rates, job openings, layoff activity and low levels of jobless claims. Like many areas of the economy, employment operates in trends, with little negativity in sight; however, expect that any signs of peaking or decelerating levels may be seen negatively and could affect the Fed’s monetary policy pace and direction. For now, though, full employment may morph into exceptionally strong employment, at least on a quantitative basis, as the quality of jobs in some cases remains debatable.
While difficult to measure economic cycle turning points precisely, consensus thinking continues to view the economy evolving from ‘mid-cycle’ more towards ‘later-cycle’. Historically, signs of change have been seen in higher wage growth (due to a lack of workers), inflationary pressures (due to a high utilization of resources) and a greater degree of risk-taking and ‘bubbly’ asset class behavior. The behavioral exuberance looks to still be contained, due to perhaps a long memory of the Great Recession and long road to recovery, which isn’t abnormal. However, corporations are taking on more debt, as is the U.S. government, making higher rates an increasingly sensitive issue moving forward. Equities have been boosted by exceptionally strong earnings growth as of late, which, of course, can’t last forever, but tailwinds still remain in place. Interestingly, alternative assets such as real estate and commodities have been decent performers in later cycle periods historically, especially if inflation were to pick up somewhat. Diversification remains a solid theme as much now as it ever has, with no asset classes individually providing a freebie at present, and spreading the risks could prove prudent—as always.