Federal Reserve Update - March 15, 2017Submitted by Jodi Vleck , Beta Wealth Group on March 15th, 2017
In a fairly dramatic turn of events over the prior few weeks, the probabilities of a Fed hike in March moved from about one-in-three or lower to almost guaranteed by the time we heard higher rate-focused comments from several FOMC members—something they often do strategically to help shape future expectations. Those expectations were realized this morning with a rate hike of 0.25%, bringing the new Fed funds rate to a range of 0.75-1.00%.
The FOMC's formal statement acknowledged that economic activity overall has continued to expand at a moderate pace, alongside a strengthening labor market, moderately higher household spending and increased inflation. The FOMC's economic projections showed little change on net in areas such as GDP growth, unemployment and inflation, although the ‘dot plot’ for expected interest rate hikes ticked higher to be on course for about three rate hikes in 2017. This change in recent tone was driven by stronger economic data, firming inflation as well as a realization that several key components of the Federal Reserve’s mandate have been reached, including inflation within target and labor market strength. A broad dashboard of Fed mandates is as follows:
Economic growth: Investor hopes are high with the new administration given the expected tax plan and other fiscal stimulus; however, progress on the legislative side has been and could continue to be tougher and take longer than originally imagined. Several estimates for Q1 GDP growth remain tempered, in the 0.5-1.5% range, while other ‘real time’ surveys intended to track economic growth show growth in a wider range and somewhat higher, primarily due to stronger capex spending from improved business sentiment. Ultimately though, growth will depend on fundamentals, and sizeable market gains are much harder to achieve this late in the business cycle while keeping in mind the headwind of challenging demographics.
Inflation: Inflation has firmed with higher commodity prices, a strong housing market (for existing homes and rents) and higher healthcare costs. While near the formal 2% inflation target, the FOMC has stated a preference for letting things ‘run hot’ to ensure better inflation traction and better insurance against any deflationary forces.
Employment: The current labor market is one of the strongest lynchpins of the FOMC argument for ‘normalizing’ rates. With strong payrolls as of late, jobless claims at multi-decade lows and the unemployment rate hovering near the theoretical place of ‘full’ employment, asking for much more could be challenging from a numbers perspective. To be clear, there are still labor market headwinds such as demographic issues and lack of adequate education/job-related training.
From an investment standpoint, not much has changed in terms of themes, but valuations across many risk asset classes have certainly expanded consistent with optimism surrounding the new administration. Equity earnings growth has turned positive year-over-year, generally a bullish sign for equities, but higher multiples should keep expectations in check. Market volatility is also extremely low which is historically unusual as well, hence it would be rational to expect higher future market volatility due to Fed speculation and geopolitical developments in the U.S. and overseas.