Fed Watch: The Day after Tomorrow

market-news
kevin-temp2
Head of Fixed Income Strategy
09/26/2016

The highly anticipated “Fed meeting of the year” has now come and gone, and investors still seem to be asking themselves: What comes next? As we discussed in our pre-FOMC blog post Fed Watch: Decision Day, the potential answer could lie in the September meeting’s accompanying policy statement. Obviously, the “will they or won’t they” debate was answered when policy makers, yet again, refrained from raising rates. However, based on market-related expectations, this decision was more or less the consensus going into last week’s convocation. So, let’s take a look at that aforementioned policy statement. As expected, the Fed acknowledged that the “labor market continued to strengthen” and the economy had “picked up” from the slow first half of the year. Yet it also recognized that it had missed its inflation target but continued to feel that the 2% threshold would be achieved, albeit based upon its most recent central tendency estimates, i.e., that it may take a year or two. Our view has always been that when the voting members were moving closer in the direction of a second rate hike, they would prepare the markets for this possibility—something the Fed had not yet done from a more formal policy perspective. After the September meeting, the policy makers have now prepared the markets for a rate hike as a potential outcome. Two phrases in particular stand out: first, the Fed stated that “the case for an increase in the federal funds rate has strengthened,” and secondly, that “near-term risks to the economic outlook appear roughly balanced.” The second reference takes us back to the Fed’s 2015 playbook, when similar language was inserted and was followed up by lift-off in December. Could history be repeating itself? Well, once again the Fed hedged its bets and emphasized that such an outcome will be data dependent, and of course global economic and financial conditions will continue to play a role. What has changed is the policymakers’ own trajectory for future rate hikes, as this year’s median forecast now looks for only one such move, and for 2017, the number has been lowered to only two increases as compared to three in June. Conclusion Certainly, the Fed does appear to be itching to raise rates at least one time this year. Chair Janet Yellen said as much at the post-meeting presser. While upcoming data may give the FOMC the opportunity to raise rates before year-end, one development that has received scant attention is the increase that has already occurred in the 3-month Libor rate due to the upcoming money market reform date. Many borrowing arrangements are pegged to this instrument, and some upward resets could be taking place. Nevertheless, it appears that as long as the economic data does not take a turn for the worse, the likely scenario at the present time would be for the Fed to potentially lift the Fed Funds target before 2017 gets ushered in. From a rate outlook, the gradual, cautious approach the Fed appears to be taking should keep Treasury yields in a volatile, range-bound setting.
About the Contributor
kevin-temp2
Head of Fixed Income Strategy
As part of WisdomTree’s Investment Strategy group, Kevin serves as Head of Fixed Income Strategy. In this role, he contributes to the asset allocation team, writes fixed income-related content and travels with the sales team, conducting client-facing meetings and providing expertise on WisdomTree’s existing and future bond ETFs. In addition, Kevin works closely with the fixed income team. Prior to joining WisdomTree, Kevin spent 30 years at Morgan Stanley, where he was most recently a Managing Director. He was responsible for tactical and strategic recommendations and created asset allocation models for fixed income securities. He was a contributor to the Morgan Stanley Wealth Management Global Investment Committee, primary author of Morgan Stanley Wealth Management’s monthly and weekly fixed income publications, and collaborated with the firm’s Research and Consulting Group Divisions to build ETF and fund manager asset allocation models. Kevin has an MBA from Pace University’s Lubin Graduate School of Business, and a B.S in Finance from Fairfield University.