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”.
At WCM, we appreciate the Fed’s measured approach to interest rate policy. Within our portfolios, we maintain conviction for U.S. equities with the strongest preference for small and mid cap companies. While equity valuations are admittedly high, corporate earnings are growing and the economy continues to expand at a consistent pace. The Fed’s cautious approach to ensure a “soft landing” should continue to support the expansion (and the markets indirectly) as we await the outcome of other potential economic drivers including the implementation of President Trump’s proposed fiscal stimulus.
While interest rate policy appears on a subtle glide path, investors should also be focused on the Fed’s approach to balance sheet policy. While the Fed’s purchase of U.S. Treasuries and mortgage bonds ended in 2014, the Fed’s balance sheet continues to be bloated at $4.5 trillion as bonds mature and proceeds are reinvested. All indications are that the Fed will maintain current monetary policy until interest rates are at higher levels. The last mention of tapering (do I dare enter that word back into the lexicon?) in May 2013 by Fed Chairman Ben Bernanke brought increased volatility and caused markets to swoon. Chairman Yellen and the governors are sure to tread lightly as they plan their exit strategy.