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The dollar halted its relentless rise of the past few months last week as the Federal Open Market Committee (FOMC) offered a set of macro forecasts that were much weaker than the markets expected.  Forecasts were cut across the board for growth and inflation for both 2015 and 2016.  The longer run expectation for inflation remained at 2%, while the longer run expectation for unemployment was reduced to 5-5.2%.  At the same time, the FOMC (as expected) removed their “patient” language in describing their posture with regard to the timing of an initial rate increase.  The combination of the lowered forecasts with removal of the “patient” language tells markets that 1) the Federal Reserve Board (Fed) is getting ready to deliver its first rate increase in more than ten years, and 2) that they would prefer to raise rates slowly given what they see as a still-weak U.S. economy.

The Fed’s assessment of a softer economy paves the way for the Fed to use a lighter touch on the monetary tiller.  Over the past several months, the effects of a strong dollar and weak energy prices have kept the global inflation rate well below where central banks can feel reasonably comfortable.  Slippage in inflation forecasts, a widening of credit spreads, mixed performance from equity markets (they have generally underperformed bonds in recent months), and a surging dollar all suggest the need for the Fed to reign in expectations of a sharp increase in interest rates.

Here is a partial list of some of the very recent and tentative developments that we are watching:

  1. Analyst consensus S&P 500 EPS forward 12 months estimates INCREASED to $122.25 now from $121.95 in February;
  2. The Treasury yield curve STEEPENED a bit after a year-long slide;
  3. Long-run inflation expectations recently ROSE slightly to 1.8% from a low of 1.6% in January;
  4. Real short-term rates, which rose steadily throughout 2014, peaked in December at -0.7% and have now SLIPPED to -1%;
  5. Corporate bond spreads STOPPED RISING recently and now stand at 1.9%.
  6. Market breadth was modestly BETTER in February and March after several months of mixed action;
  7. Signs of financial system stress (measured by the St. Louis Fed’s Financial System Stress Index) EASED recently; and
  8. Other signs of improvement among various measures of monthly domestic and foreign economic conditions.

We don’t want to oversell these points as the improvements are only recent and relatively small, but the improvements are at least broadly distributed (the list above is a partial list).  Our current near-term forecast is to trend modestly higher toward a level near 40.  Current “tactical” allocations are modestly below the midpoint of their policy ranges reflecting the overall weakening trend of fundamental conditions.