The U.S. Federal Reserve (Fed) is, for the most part, basically delivering on what the market is expecting. So, in that regard, Fed watching is getting to be a lot like professional sports watching: Most of the times things work out as expected, and when there is a surprise, we talk about it ‘til the cows come home.
We talk about the surprises endlessly for sure, but most of the time we have no conviction about whether the surprise was a fluke or is likely to persist.
The March Fed meeting fit that mold perfectly. As stated above, the Fed meeting worked out as expected, with one exception, and that is something worth talking about, but I don’t have much conviction that the Fed’s thinking has changed that radically.
First, the outcome of the meeting. Not much surprise at all:
- The Federal Open Market Committee (FOMC) raised the Fed Funds rate by 25 basis points (bps), as was widely expected, to a range of 1.5%-1.75%.
- The Fed confirmed three hikes for this year, maybe four, but we won’t know for a while.
- There will be three rate hikes in 2019 and a few more in 2020.
- The U.S. growth outlook has improved due to the fiscal stimulus for 2018 and 2019.
- The U.S. unemployment rate projection is going below the non-accelerating inflation rate of unemployment (NAIRU)1 and will persist at that level for some time.
So far, in the surprise factor, the March Fed meeting was a lot like the New York Yankees beating the Minnesota Twins. Given the Yankees’ .730 winning percentage against the Twins since 2002,2 the outcome is not a surprise if you are a long-suffering Twins fan. Yet, in a playoff game last September between the Yankees and the Twins, Minnesota took a three-run lead in the third inning and the score stood at 3-0. Were we about to see a surprise?
And, since we are using sports metaphors at the moment, for a rookie, Jay Powell was quite poised and suave in his post-game interview.
Surprise: Fed Revises Inflation Outlook
For a Fed that has been somewhat doctrinaire over the last few years, the surprise came in its latest median inflation outlook, which was revised higher to 2.1% for both 2019 and 2020.
In my opinion, if this thinking persists it will be a game changer and we could end up with a reeeeaaaally long cycle for the market. The implication would be that even if the fiscal stimulus-driven growth outlook strengthens over the next few years, the Fed may look beyond that and not kill the U.S. economy.
Obviously, it is entirely premature to conclude that just yet. In that playoff game last fall, the Yankees scored nine runs in the next two innings and the surprise factor was fully extinguished. It could be the same for the Fed’s reaction to inflationary pressures when they manifest themselves.
But, hey, we are allowed to dream, aren’t we?
The bottom line for the FOMC meeting is that the U.S. economy remains strong, inflation remains under control for now, and the Fed remains in a persistent tightening mode. As a result, my market outlook remains the same: One step forward due to economic strength, and three quarters of a step back due to Fed tightening fears.
The net result is still likely to be higher markets overall by year-end, in my view. Away from the U.S., growth in emerging markets remains quite good and may be strengthening. Emerging markets remain our favorite destination in both equities and fixed income.
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