To no surprise, the Federal Open Market Committee (FOMC) voted to raise the Federal Funds rate by 0.25% to a range of 0.75% – 1.00%. Fed officials have been telegraphing this increase for a number of weeks and Fed watchers felt it was a certainty as the meeting approached. That certainty should have been priced into markets but the second rate increase in the last three months still boosted markets as the S&P 500 Index added almost 20 points to 2,385. On the fixed income side, Treasuries rallied with the yield on the 10 year Treasury falling by over 10 bps to 2.49%. Investor action was most likely driven by further proof that the Fed is on track to normalize interest rates as the economy prospers. However, a review of the Fed’s statement showed little to no change to interest rate and economic forecasts. The Fed seems content to take a gradual approach in its rate policy, which is all fine and good for market participants. As we enter the ninth year of this market cycle, with job growth continuing and inflation in check (albeit close to the Fed’s stated target of 2%), a slow and steady hand on the tiller gives comfort. And to calm those investors concerned that the Fed may be entering a new, more aggressive phase of policy action, Janet Yellen stated in her press conference that the Fed expects to remain accommodative for “some time”.
Author: Jonathan London
February delivered strong returns in several areas of the world’s capital markets with the exception of key European equity and credit markets.
To no surprise, the Federal Reserve voted to raise its short-term interest rate target yesterday. The move brings the federal funds rate – the overnight lending rate between banks – to a range of 0.50% – 0.75%. The market expected this move based on recent Fed governor comments and the trends of its two primary bogeys: employment and inflation. With unemployment at 4.6% and inflation moving toward the 2% target, the planets were in alignment for the rate move. No doubt the committee members were also influenced by President-elect Trump’s stated policy agenda of fiscal stimulus, tax reform and regulatory reform, all of which should serve to spur U.S. economic growth (although there was no mention of these considerations in the Fed’s post-meeting statement).
Although the Fed met near-term expectations, markets sold off yesterday as investors assessed the latest “dot plot” which details the anticipated trajectory of rates over the next few years. The chart indicates three rate increases in 2017, an increase from two in the Fed’s September statement. More rate increases translate to higher borrowing costs which could stilt the impact of Mr. Trump’s intended policy actions, giving investors pause. But, a lot of factors will determine the future path of interest rates – investors shook off their initial concerns and the equity rally resumed today.
At WCM, we view the Fed’s actions as progress towards interest rate and central bank policy normalization. As asset allocators, we look forward to the time when market returns are driven by corporate earnings, economic fundamentals, and valuation, rather than monetary policy manipulation.
The third and final U.S. Presidential Debate was Wednesday and the general consensus is that Hillary Clinton was the winner (although the impact of later debates tends to be less than initial ones). The reaction in the markets was a virtual yawn and it appears that investors moved on. Any market movement in coming days will likely be reactions to other headlines including that U.S. jobless claims increased after spending several weeks at a four decade low or that the European Central Bank (ECB) is keeping its quantitative easing program and interest rates unchanged. While we have seen some predictability in the market this should not be confused with health or strength. We have observed a persistent pattern of fragility, including a U.S. market, as measured by the S&P 500, making lower highs and lower lows, that has become more apparent since this Summer. Interest rates, both policy and market, are near zero and in some cases negative, equity and bond market valuations are full or extended based on several common measures, and the policy cupboard is becoming increasingly bare. Our concern is that there is little that would be welcomed by the market in either candidate outcome, and given tenuous fundamentals and economic conditions, capital markets could react adversely to any unexpected bad news.