Federal Reserve Chairwoman Yellen slid down the chimney yesterday with a bag full of goodies flipped over her shoulder. As she read the Federal Open Market Committee’s press release at the end of its two-day meeting at 2 pm yesterday, the markets rallied in jubilation.
“The S&P 500 surged 2 percent to 2,012.89 by the 4 pm close in New York, the biggest one-day gain since October 2013,” reported Bloomberg. Why?
Because the FOMC had decided that “the current 0 to 1/4 percent target range for the federal funds rate remains appropriate,” the press release read. The Fed did not raise interest rates, which means cheap money and loans, and a continuation of low debt expenses resulting in higher corporate profits.
Of course, even before this recent FOMC meeting the markets knew the Fed was not going to raise interest rates this time around. But it was the wording of the press statement that blew a new gust of wind in equities’ sails.
The question going into the meeting was whether the time period for the first interest rate hike in more than six years would be specified, or at least alluded to. Well, it wasn’t. Instead, the FOMC press release remained as evasive as ever regarding the timing of the first rate hike, stating simply that “if incoming information indicates faster progress… then increases in the target range for the federal funds rate are likely to occur sooner”, but “if progress proves slower than expected, then increases in the target range are likely to occur later”.
That’s it right there… the entire FOMC press release boiled down to just one line: ‘maybe sooner, maybe later’ is all they really wrote. And that was good enough for the equities market, which surged upward for its biggest one-day move in over two years.
Yet it was completely different story on the bond market. “Yields on 10-year Treasury notes climbed eight basis points to 2.14 percent and the Bloomberg Dollar Spot Index rose 0.9 percent as the yen slid,” Bloomberg added.
Apparently, the bond market is under the impression that the Fed has somehow moved just a little bit closer to raising rates, given the slight change in wording in a few key places of the release.
On closer examination, however, we find that no such change in position has taken place within the Fed. It is still as dovish as ever.
Getting A Little Closer, or Not?
In acknowledging the great economic progress being made lately, the Fed gave rise to the “idea” that it may be getting closer to moving on interest rates when it opened yesterday’s press release with:
“Information received since the Federal Open Market Committee met in October suggests that economic activity is expanding at a moderate pace. Labor market conditions improved further, with solid job gains and a lower unemployment rate. Household spending is rising moderately and business fixed investment is advancing.”
Indeed, the ever important monthly non-farm payrolls number has averaged greater than 200,000 new jobs being created each month since late 2010, which is slightly better than the job creation rate was pre-crisis, as depicted below. Since “full employment” is one of the Fed’s chief mandates, such steady job creation puts a check-mark next to this item on the Fed’s “to-do” list.
Source: TradingEconomics.com
Another likely indication that the Fed could be getting closer to raising interest rates is the growing dissention among committee members, which has risen to two:
• Richard W. Fisher, who believes “improvement in the U.S. economic performance since October has moved forward… the date when it will likely be appropriate to increase the federal funds rate”, and
• Charles I. Plosser, who believes “that the statement should not stress the importance of the passage of time as a key element” in the committee’s decision making, and “should not emphasize the consistency of the current forward guidance with previous statements”; Plosser would like to see the committee break away from its previous language which ties it down to an arbitrary timeline.
But apart for this, there really was nothing else in the FOMC’s press release which even remotely hinted to any change in the committee’s highly accommodative stance. In fact, there is still plenty of wording that communicates continued dovishness for a long time to come.
Low Inflation Concerns Linger
The Fed’s staunchly accommodative stance centers around the rate of inflation. To achieve its second chief mandate of “price stability”, the Fed would like to see inflation remain on a stable incline that is tilted 2% upward annually.
However, such a slope for inflation has been elusive, and may have actually retracted recently, as the press release suggests:
“Inflation has continued to run below the Committee’s longer-run objective [of 2%], partly reflecting declines in energy prices. Market-based measures of inflation compensation have declined somewhat further; survey-based measures of longer-term inflation expectations have remained stable.”
The fall of energy prices since June in which crude oil has plunged nearly 50% and gasoline has fallen over 30% in just six months, has put downward pressure on consumer prices not just on fuel and home heating but also on consumer prices in general, as lower energy costs save companies money which drive down the prices they charge consumers for their products and services.
What is more, the recent rise in the value of the U.S. dollar has applied further downward pressure on inflation, since the extra buying power allows consumers to purchase more goods and services for less money.
Since inflation is so important to the Fed’s price stability mandate, it will be closely watched and considered before interest rates are increased:
“In determining how long to maintain this target range, the Committee will assess progress – both realized and expected – toward its objectives of maximum employment and 2 percent inflation,” yesterday’s statement promised. “The Committee judges that it can be patient in beginning to normalize the stance of monetary policy… especially if projected inflation continues to run below the Committee’s 2 percent longer-run goal,” it stressed.
Don’t Count on Higher Rates in 2015
The question now is, will inflation catch up to the Fed’s 2% target sooner or later? Much of that depends on oil and gasoline prices, as well as on the strength of the U.S. dollar – and neither is expected to change in 2015.
On the energy front, if it is indeed the case that a glut of oil and gas on the market is keeping prices down due to an oversupply which has been building up for years, then we cannot expect such excessive supplies to be consumed in just one year. Especially since OPEC is continuing to resist cutting production.
On the USD front, central banks around the world from Japan to Europe are continuing to lower their interest rates and expand Quantitative Easing measures to pump more liquidity into their economies, weakening their currencies which strengthens the U.S. dollar. And such pro-USD measures are not expected to be reversed for at least two more years.
Hence, inflation in the U.S. is going to remain subdued for several more quarters to come, given the continuing expectation of low energy prices which pulls consumer prices down from below, and a strong USD which pushes consumer prices down from above. Inflation simply cannot reach the Fed’s 2% target any time soon, perhaps not even until early 2016.
In fact, the Fed has retained its long held wording that “even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run.”
In other words, even when the Fed achieves it unemployment and inflation targets, it may still put off raising interest rates for longer.
A Perfect Storm for U.S. Equities
Given all of the above conditions, 2015 is most assuredly going to be one of the best years in U.S. stock market history, as multiple conditions are all coming together to feed the equity bull with spinach, including:
• low energy prices which save companies and consumers money, spurring increased consumerism and corporate profits,
• low foreign currencies which strengthen the USD increasing American consumers’ and corporations’ buying power,
• continued strong job creation which puts more Americans to work and more spending money in their pockets, and
• a central bank which is still extremely “patient” regarding the raising of interest rates.
As such, U.S. bonds will likely remain high and yields low as interest rate hikes will keep getting postponed, and U.S. equities will continue to climb on the realization that the Fed is simply not going to budge any time soon.
Joseph Cafariello
