Strong Signals Support the Fed’s Path Forward

June 15, 2018  | by Ryan Driscoll, Kristofer Kwait

Industry Knowledge | Market Commentary

Summary

  • The FOMC voted unanimously to raise interest rates at the June meeting, citing numerous positive trends in the economy.

  • Fed members have raised their forecasts for economic growth and inflation resulting in the Fed “dots” now indicating four rate hikes in 2018 – up from three previously.

  • On inflation, policy makers forecast a slight overshoot of their core PCE target starting in 2018 at 2.1 percent, and running through 2019 and 2020. As opposed to the 2020 overshoot in March’s projections.

For the most part, the markets expected Federal Reserve Chairman Jerome Powell to raise rates at the June meeting and to have an optimistic tone when discussing the domestic economy. Most of the recent data didn’t seem to justify a radical change in the Fed’s outlook. The slight downward revision in real GDP for 1Q2018 and minimal uptick in inflation are hardly enough to skew the Federal Open Market Committee’s (FOMC) view in either direction. One important detail that market participants were focused on was the projection of future interest rates, specifically, the median 2018 rate, which would outline the potential path for the Fed Funds rate over the remainder of the year.

Ultimately, the decision to increase rates was unanimous as the vote was 8-0. Federal Reserve officials raised interest rates for the second time this year and upgraded their forecast to four total increases in 2018, as unemployment fell and inflation exceeded their targets faster than previously projected. The FOMC statement indicated their belief that the U.S. economy is on track, as they said the economy is growing at a “solid rate',' job gains have been “strong'', consumer spending has picked up and investment continued to grow “strongly''.

The changes to the economic forecasts released along with the FOMC policy statement show that Fed members have raised their forecasts for economic growth and long run inflation. There were no changes to the employment forecasts.

  • The median forecast for 2018 GDP was revised up to 2.8 percent from 2.7 percent in March.

  • The long run unemployment rate median estimate remained at 4.5 percent and, in the near term, Fed officials still expect the unemployment rate to fall to the mid-three percent range.

  • On inflation, policy makers forecast a slight overshoot of their core PCE target starting in 2018 at 2.1 percent, and running through 2019 and 2020. As opposed to the 2020 overshoot in March’s projections.

As mentioned in a previous post, the Fed “dots” track changes in the projected path of interest rates. The consensus forecasts now reflect an expectation for four rate hikes in 2018. The 2018 average forecast is 2.4 percent, which is a quarter of a percentage point higher than March. The 2019 average increased to 3.1 percent, while the 2020 average stayed at 3.4 percent. The median estimate implied three more increases in 2019 to put the rate above the level where officials see policy neither stimulating nor restraining the economy. The long-run average rate expectation was unchanged at 2.9 percent.

CH1-FedDots

This was the seventh rate hike by the FOMC since December 2015 and, if the Fed projections are accurate, investors will have to endure a total of 13 rate hikes during this tightening cycle. Even with this most recent rate increase, monetary policy remains accommodative with a fed funds rate at or below the current rate of inflation. So the question is, “are we halfway there?”

The short answer is – possibly if the current economic conditions persist and domestic growth continues in a relatively tame inflationary environment. However, in the constantly changing global markets, mired in headlines focused on trade wars and political discontent, no outcome is definite. We are closely watching not only interest rates and inflation but also corporate earnings and global growth for any changes on the horizon that would influence monetary policy – positively or negatively.

Overall, we still have a constructive view on equities mindful that the FOMC actions are focused on slowing the economy and controlling inflation. For this reason we have become more cautious in the current environment and have taken steps to lower, but not eliminate, our equity overweight moving closer to a neutral equity positioning. Nonetheless, it is clear the path for interest rates is higher and for this reason equities remain attractive relative to fixed income investments.

Authors

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Ryan Driscoll is responsible for trading, investment analysis. He is a member of the Treasury Solutions team since its inception. Ryan is an active participant in the investment and rebalancing process, manages the quarterly reporting process and is actively engaged with Treasury clients. Prior to joining Commonfund, Ryan worked at Sailfish Capital Partners, a multi-strategy fixed income fund, where he served on the Emerging Markets team. Prior to that, he was on the fixed income team at Grantham, Mayo, Van Otterloo & Co. and was an equity/fixed income trader at Loring, Wolcott and Coolidge, in Boston. Ryan received his B.S. in Finance and M.S. in Global Financial Analysis (with Distinction) from Bentley College. He is a CFA Charterholder and is a member of the Boston Securities Analyst Society and CFA Institute.
Ryan Driscoll
Director, CFA
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Kristofer Kwait is Deputy Chief Investment Officer, and Head of Investments responsible for leading the marketable equities, fixed income, hedge funds and real assets investment teams as well as analytics. Prior to his current role, Kris was head of the Hedge Fund Strategies Group. Previously, he served as head of hedge fund research with responsibility for overseeing the design and implementation of proprietary models for manager selection, portfolio construction, and risk management. Before joining Commonfund, Kris was a proprietary trader at both Andover L.L.C. and A.B. Watley, where he managed relative value equity strategies. Prior to his experiences as a trader, he was a stockbroker at Smith Barney. Kris attended pre-college at Juilliard School of Music, has a B.S. from Purdue University and an M.B.A. from the Yale School of Management.
Kristofer Kwait
Deputy CIO and Head of Investments

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Disclaimer

Information, opinions, or commentary concerning the financial markets, economic conditions, or other topical subject matter are prepared, written, or created prior to printing and do not reflect current, up-to-date, market or economic conditions. Commonfund disclaims any responsibility to update such information, opinions, or commentary. To the extent views presented forecast market activity, they may be based on many factors in addition to those explicitly stated in this material. Forecasts of experts inevitably differ. Views attributed to third parties are presented to demonstrate the existence of points of view, not as a basis for recommendations or as investment advice. Managers who may or may not subscribe to the views expressed in this material make investment decisions for funds maintained by Commonfund or its affiliates. The views presented in this material may not be relied upon as an indication of trading intent on behalf of any Commonfund fund, or of any Commonfund manager. Market and investment views of third parties presented in this material do not necessarily reflect the views of Commonfund and Commonfund disclaims any responsibility to present its views on the subjects covered in statements by third parties. Statements concerning Commonfund’s views of possible future outcomes in any investment asset class or market, or of possible future economic developments, are not intended, and should not be construed, as forecasts or predictions of the future investment performance of any Commonfund fund. Such statements are also not intended as recommendations by any Commonfund entity or employee to the recipient of the presentation. It is Commonfund’s policy that investment recommendations to its clients must be based on the investment objectives and risk tolerances of each individual client. All market outlook and similar statements are based upon information reasonably available as of the date of this presentation (unless an earlier date is stated with regard to particular information), and reasonably believed to be accurate by Commonfund. Commonfund disclaims any responsibility to provide the recipient of this presentation with updated or corrected information. Past performance is not indicative of future results. For more information please refer to Important Disclosures.