Fed Holds Steady: Macro Strategists React

The ducks are not lining up for liftoff yet.

ETF.com
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Reviewed by: etf.com Staff
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Edited by: etf.com Staff

With the U.S. Federal Reserve keeping interest rates unchanged today while also acknowledging global economic weakness, we asked several macro strategists their reactions to today’s decision.

Roger Aliaga-Diaz: senior economist; Vanguard (Aliaga-Diaz will be speaking at the ETF.com Fixed Income conference taking place Nov. 4-5 in Newport Beach, California)

The Fed's decision to hold off on a rate increase is a clear indication to the markets that this rate cycle will be different, with international conditions and U.S. dollar strength weighing more on the decision than in the past.

We’re concerned with the Fed's acknowledgment of recent market volatility in its decision. The Fed runs the risk of being held captive to the markets, as, paradoxically, much of that volatility is due to the anticipation and uncertainty around when the Fed will move.


Vanguard believes that focus should remain on how the Fed proceeds after the initial increase in rates. Given current conditions, we believe a take-off in 2015 is warranted, and continue to stress our view of “low and slow.” The U.S. economy remains strong relative to global peers, and we expect that resiliency to remain.

Scott Minerd: Global CIO; Guggenheim

The introduction now of global financial conditions is apparently a new condition. Yet there is a very good probability that global volatility will not materially decline between now and the remainder of the year, so the Fed could push normalization off into 2016.

Based on Fed Chair Janet Yellen’s comments, however, it’s clear that they want to move this year. Whether they have the gumption to do it, is the question. As I have said, the Fed has a dilemma: It is extremely sensitive to being criticized for adding to market volatility in the short run, but also very sensitive to criticism for overheating the economy in the long run.

December seems most likely in light of seasonal factors that typically give a lift to markets, and by then hopefully, a number of concerns could fade.

As for today, it seems the Fed didn’t want to take the short-term pain for raising rates, so it traded short-term pain for the risk of remaining too accommodative in the long run—which could cause other problems later on—thereby kicking the can down the road.

Brian Jacobsen: chief portfolio strategist; Wells Fargo Funds Management

It’s all about the global outlook and inflation. You can have the unemployment rate drop to 4 percent and if you don’t see inflation, the Fed has no impetus to act. The Fed doesn’t create jobs, so it’s focused on inflation. In the past, when the Fed has acted without clear signs of inflation, it’s rued the decision. This was very prudent of the Fed.

The Fed isn’t beholden to China. China matters, but it didn’t force the Fed to wait. The Fed learned from its aborted rate hike of 1997 that global conditions matter. In 1997, the Fed ignored global events to its peril.

As an institution, the Federal Open Market Committee learns from its past mistakes. I’m sure it’ll make new mistakes, but hiking rates while risks to the outlook grow isn’t one of the mistakes it will make. The FOMC recognized risks to the outlook that emanate from outside the U.S.

The Fed is “data-dependent,” which means the outlook for growth and inflation matter more than what growth and inflation were the last few months. On that basis, it was prudent risk management for the Fed to wait.

Rob Stein: chief executive officer; Astor Investment Management
The Fed could have hiked today, but didn’t because: 1) the international and China environment; and 2) slightly weaker inflation. It appears the Federal Open Market Committee is a little bit uncertain if the above will impact the steady improvement in U.S. labor markets and growth. The FOMC also stated the lower inflation is because of energy prices, which it believes to be temporary, but it still wants to wait and see if that’s true.

Most FOMC members see hikes this year, and Fed Chair Janet Yellen said they could rise in October, although it appears she must be the only one who believes that. Members will also wait to see continued labor market improving and some sign of solidity in inflation.

Once the Fed starts hiking rates, it will likely not hike at a rapid pace, and monetary policy should be quite accommodative for a long time. Recall that the Fed stopped easing last year when purchases ended. Markets are a bit more volatile since then, but still positively sloped.

The S&P 500 is a bit higher than last year at this time and rates are a bit lower—so no harm, no foul. Our proprietary economic indicators are still above trend and signaling growth and we see an expected positive return for risk assets. Onward we should go …

Shehriyar Antia: founder and lead strategist; Macro Insight Group

Today’s Federal Open Market Committee meeting came in very much as I expected: There was no policy action and the outlook remained fairly upbeat. The upbeat tone keeps hope alive for a rate increase later this year. Although there was only one dissenting vote, I would expect the minutes to reveal there was additional support for a rate increase today.

Make no mistake: A rate increase continues to depend on inflation. The FOMC maintained its optimistic view by referring to the ongoing soft inflation as temporary. Importantly, the forward-looking part of the statement made mention of “uncertainty abroad” as increasing downside risks to both economic growth and inflation.

What I did not expect was the extent of downgrades to inflation and rate forecasts for this year and beyond—a decidedly dovish tilt. The number of FOMC members who called for rate liftoff after 2015 rose from two to four. Inflation is not expected to get back to 2 percent until 2018!

As for what to expect, October rate action is very unlikely, and a move in December is very much on the table. A move in December is dependent on firmer footing for inflation, stabilizing dollar and commodity/energy prices, and leveling off of import price deflation.

Katherine Klingensmith: executive director, senior strategist; UBS Financial Services

The Fed did not hike rates, and overall, the statement, the forecasts and the press conference paint the picture of a dovish Fed. However, 13 of the 17 FOMC members still anticipate a rate hike by the end of 2015, and it therefore does not surprise us that markets did not react that sharply.

The statement highlighted global developments as a key consideration for the Federal Open Market Committee, as well as the strong dollar and its impact on inflation dynamics. We do not think the FOMC is particularly concerned about the value of the dollar as such, but certainly keenly aware of "developments abroad" and the risks they pose to the U.S. recovery and inflation dynamics.

The dollar did lose value following the decision, certainly belying that some investors were expecting a hike today. However, while the euro jumped up a full big figure against the dollar—hovering at 1.14—it did not skyrocket, suggesting a shift in timing and not in scenario for the Fed.

We still expect that the Fed will move soon. With the European Central Bank committed to substantial additional balance sheet expansion, we continue to anticipate that the two largest central banks will indeed diverge in monetary policies soon.

Mark Dow: founder; Dow Global Advisors

The Fed decided to keep rates on hold today. More surprising, it didn’t start laying the groundwork for October. This increases the odds of a December hike.

The key elements holding the Fed back are international weakness and stubbornly low inflation.

In the press conference, Chair Janet Yellen made it clear that the Federal Open Market Committee would still like to see further strengthening of the labor market. She indicated that it had already seen enough labor improvement to meet the standard that it had been looking for, but, in light of increased global growth concerns, it now feels it needs more labor market strength to enhance our “insulation” from global vagaries.

On inflation, Yellen addressed the uncertainties regarding the links between monetary policy and low inflation. She reiterated the FOMC’s expectation that continued improvement in the labor market and the fading of transitory commodity price effects would ultimately allow inflation to get back on a path up toward 2 percent.

But reading between the lines, she sounded less confident on this point than ever. And it is not clear if its Plan B is “zero for longer” or “leap of faith.” Watch this area. If inflation doesn’t respond as the FOMC expects, the bar for labor market strength and calmer international waters will likely be raised yet further.

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