Economic strength fuels Federal Reserve hike
INSIGHT ARTICLE |
As expected, Federal Reserve officials raised the federal funds rate 0.25 percent at their September meeting to a range of 2.00 percent to 2.25 percent and reiterated expectations for another 0.25 percent rate increase at the December FOMC meeting. The committee upgraded their forecast for economic growth and expects inflation to track near their policy target rate. Fed policymakers revised their 2018 Real GDP forecast higher 0.3 percent to 3.1 percent, and expect core inflation to track 2.1 percent by year-end. Fed policymakers still forecast three rate increases in the federal funds rate in 2019. In addition to raising short term-rates, Fed policymakers voted to continue to shrink the Federal Reserves’ balance sheet. Beginning in October, the Fed will increase the pace of balance sheet reduction $10 billion to $50 billion per month through December.
Federal policymakers upgraded their assessment of U.S. economic growth again citing improved trends in both household spending and business investment. Full impacts of fiscal policy and global monetary policy changes will take time to flow through economic channels and may cause investors to take a wait-and-see approach. Fed fund futures indicate the market is pricing in just a 76 percent chance the Fed raises rates at the December meeting and only twice in 2019. In our view, monetary policy divergence will be increasingly difficult as effects of higher short-term rates and U.S. dollar strength work through global economic channels. Although Federal Reserve Officials forecast 3.1 percent Real GDP growth in 2018, median expectations forecast growth to steadily decline to 2.0 percent through 2020, signaling benefits from the 2018 Tax Cut and Jobs Act may be short-lived.
U.S. equities were mostly unchanged following the widely expected rate increase. Quiet equity markets offered confirmation of the rate hike, but drew attention to the removal of a sentence that described monetary policy as accommodative from the June statement (and previous statements). In our view, removing the sentence is consistent with median expectations from Fed policymakers that monetary policy risks are more balanced. Beginning in October, global monetary policy will be less accommodative as the Fed shrinks its balance sheet and the ECB tapers its own asset purchase program. While we continue to assess the potential impacts of central bank policy decisions on equity markets, we believe U.S. dollar strength and trade policies will drive short-term equity returns.
The spread between 2-year and 10-year treasury yields fell 2 basis points to 23.5 basis points as long-term rates declined more than short-term rates. The spread between 3-month and 2-year yields fell 1.1 basis points to 61.7 basis points and suggest the Fed may only be able to increase rates two more times before risking a yield curve inversion. Looking ahead, we will monitor the effects of rising treasury issuance, the path of monetary policy normalization and global effects of a monetary policy less accommodative.
We continue to believe that investors should be patient and adhere to a well-constructed, diversified investment portfolio anchored to your goals and time horizon. Despite elevated uncertainty, we do not find compelling reasons at this time that would justify overriding our asset allocation methodology.
Information in this document was prepared by DiMeo Schneider & Associates, L.L.C. and although information in this document has been obtained from sources believed to be reliable, RSM US Wealth Management LLC, DiMeo Schneider & Associates, L.L.C. and their respective affiliates do not guarantee its accuracy, completeness or reliability and are not responsible or liable for any direct, indirect or consequential losses from its use. Any such information may be incomplete or condensed and is subject to change without notice. The Frontier EngineerTM is a registered trademark of DiMeo Schneider & Associates, L.L.C.