Monday Morning Minute 091718
Full Steam Ahead
The Federal Reserve meets September 25-26 to discuss next steps for monetary policy and interest rates. Firming inflation, strong growth, and low unemployment all point toward another increase in the federal funds rate. If the Federal Reserve does raise rates as expected, the federal funds rate will be at 2.25%, which will be above the central bank’s forecast inflation rate, but well below where rates peaked in past tightening cycles (chart, below).
Real Rates are Back
With short-rates equal to inflation, the “real” interest rate is no longer negative. How high the rate actually moves above the inflation rate ultimately depends on the Federal Reserve’s outlook for inflation and the economy, and their opinion of what the “natural” or “neutral” rate would be if the economy was in “balance.” In the past, it was thought that the “natural” short-term rate was about 2% above the inflation rate, but this assumption has been challenged since the financial crisis. Since then, many have assumed that the long-run “natural” rate would stay depressed indefinitely, but this assumption is becoming challenged as employment, wages, growth and inflation appear stronger than expected.
Don’t Shoot the Messenger
When Jerome Powell holds his press conference on Wednesday, September 26th, we believe he will stay with the Federal Open Market Committee’s steady, gradual tightening story in response to what the data is telling him and the committee. We expect to see at least two more rate increases between now and spring of next year so long as trends persist. Continued gradual increases should further lift required returns on other short-term, high-quality fixed income assets above the forecast inflation rate — something savers have not seen in many years.
Kevin Caron, CFA, Senior Portfolio Manager
Chad Morganlander, Senior Portfolio Manager
Matthew Battipaglia, Portfolio Manager
Suzanne Ashley, Analyst
WCA Fundamental Conditions Barometer Description: We regularly assess changes in fundamental conditions to help guide near-term asset allocation decisions. The analysis incorporates approximately 30 forward-looking indicators in categories ranging from Credit and Capital Markets to U.S. Economic Conditions and Foreign Conditions. From each category of data, we create three diffusion-style sub-indices that measure the trends in the underlying data. Sustained improvement that is spread across a wide variety of observations will produce index readings above 50 (potentially favoring stocks), while readings below 50 would indicate potential deterioration (potentially favoring bonds). The WCA Fundamental Conditions Index combines the three underlying categories into a single summary measure. This measure can be thought of as a “barometer” for changes in fundamental conditions.
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