June 2017 Market Review

The Federal Reserve has reemerged front and center in the debate over interest rates. While the Fed never takes a backseat in the minds of bond investors, the preeminence of Fed activity had been overshadowed by the fiscal policy implications of the new Administration’s tax cutting and infrastructure spending plans. Fed policy makers moved forward with another rate increase, the second this year and the fourth in the current tightening cycle, along with an outline for the potential tapering of bond purchases. Their “dot plots” indicate that they expect another rate increase this year, and three more in 2018. Chair Yellen has indicated that the setback in inflation is likely a temporary phenomenon, but the market consensus thinks otherwise. It is always interesting to have conflicting views in the market. A continuation of rate hikes without a pickup in inflation, the argument goes, will choke off the already tepid growth in the economy. 

While we believe the Fed would indeed like to “normalize” rates and the size of their balance sheet, its useful to put their recent rhetoric in perspective. Over the past several years, the Fed’s dot plot projections have frequently overstated the pace of tightening. The decision makers at the Fed have been quick to become “data dependent;” i.e. change their minds as they make new judgements on the numbers. Simply put, the Fed will adjust to the facts, making a policy mistake less likely.

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