Debates & Rates

By David B. Armstrong, CFA | Sep 21, 2015 | Weekly Market Commentary

For the week, U.S. stocks were pretty much flat as the Federal Reserve (Fed) left interest rates unchanged.  This prompted some rather mixed emotions… On one hand, the Fed’s low interest rates that have been in place since the financial crisis and have supported equities remain. On the other hand, the Fed expressed concern about the global economy (China, emerging markets, etc.) which has been the big contributor to all of this increased market volatility. There was U.S. Government bond buying on the news which causes yields to fall. The yield on the two-year note had its biggest one-day drop since December of 2010. The U.S. Dollar fell against the Euro and the Yen after the news.  This decision to wait could put downward pressure on the U.S. Dollar. (Remember, the strong U.S. Dollar was one of the reasons given by U.S. corporations for poor first quarter earnings.)

See last week’s blog where I presented reasons why the Fed would and would not raise rates, but the motives and logic mentioned were … unexpected. In past meetings, the Fed focused on the labor market. This time, they pointed to a lack of inflation, the strength of the U.S. dollar and global economic issues as the reasons for its decision. So this shift made the market uncomfortable because it changed the metrics everyone thought they were measuring by.  I heard one commentator on TV refer to it as “the Fed moving the goalposts.” They are basically now saying that the labor market and the economy still aren’t strong enough to justify a rate increase.

So the big questions in my mind are:

1. Is the Fed now managing the U.S. economy OR the global economy?
2. Does this mean that we have to wait for inflation to go up before a raise?

Fed Chief Janet Yellen said, “[the economy] has been performing well and impressing us by the pace at which it is creating jobs and the strength of domestic (U.S.) demand.” But for some reason, there wasn’t enough economic vigor for the Fed to pull the trigger on the first rate increase in the fed funds rate in almost ten years. In a 9-1 vote, the Federal Open Market Committee (FOMC – the committee that decides monetary policy) decided to hold the target for the fed funds rate at 0 – 0.25% … or unchanged. The lone dissenter opted for a 0.25% boost in the fed funds rate.

Then there was this nugget taken right from the statement:

 “Recent global economic and financial developments may restrain economic activity somewhat and are likely to put further downward pressure on inflation in the near term.”

Translation:

China and emerging market risks were the primary culprits, and Yellen wasn’t shy about expressing her concerns.

“A lot of our focus has been on risks around China, but not just China, emerging markets, more generally in how they may spill over to the United States,” Yellen said at the press conference.

Secondarily, low inflation is still giving some Fed officials the jitters.

Keep in mind that our exports to China account for less and 1% of our GDP.

So for now, while a rate increase is still on the table for this year, I don’t see the China concern going away anytime soon, and there have been few signs that the official measures of inflation are beginning to accelerate.

You’ve seen gas prices, right?

Call with questions or concerns.

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