Central Bank: the Fed met expectations by taking a ‘wait and see’ approach to recent economic developments

Rick Rieder, Chief Investment Officer Global Fixed Income BlackRock e Co-Manager BlackRock Fixed Income Global Opportunities, discusses Fed policy. After December’s 25 basis point policy rate increase, to a target range of 0.25% to 0.50%, most market observers did not expect any dramatic moves from yesterday’s statement from the Federal Reserve’s Federal Open Market Committee, and that expected outcome came to pass. Still, some of the language changes to the Fed’s statement are worth examining. The Fed generally met expectations yesterday by taking a “wait and see” approach to recent economic developments.

For example, it’s clear that the Fed has downgraded its expectations for near-term economic growth. Further, it suggested that household spending levels and business fixed investment grew at “moderate” levels, instead of the stronger “solid rates” referred to in December. Nevertheless, the December nonfarm payrolls print of 292,000 jobs gained, alongside the 50,000 additional jobs gained in the prior two months due to revisions, led to a more optimistic tone on the labor market front. “The irony is that in our view the labor market improvement has peaked and will moderate from here in 2016 – explains Rieder  – In the end, by waiting so long to begin normalizing rates, the Fed has allowed the economic cycle to crest as it headed into the rate hiking cycle, which will present a dilemma for the central bank this year”.
 
On inflation and other influences to the monetary policy reaction function, the Fed added: “Inflation is expected to remain low in the near term, in part because of the further declines in energy prices, but to rise to 2 percent over the medium term as the transitory effects of declines in energy and import prices dissipate and the labor market strengthens further. The Committee is closely monitoring global economic and financial developments and is assessing their implications for the labor market and inflation, and for the balance of risks to the outlook.” This language both acknowledges the persistently low levels of inflation, as well as their underlying causes, and suggests that the Fed is also watching financial conditions carefully, and probably those tied to China’s economy particularly closely, without explicitly saying so. This makes sense, as we think that left tail risks for markets have not only grown appreciably in the past year, as we’ve suggested for some time, but also that they are likely to remain elevated in 2016. We are not overly concerned about a developed market economy recession this year, although as mentioned U.S. growth has likely crested and will slow from here, but the economic situation in China is a large part of this elevated left tail risk today.
 
“As we have long suggested, the Fed is likely to move only very cautiously on rate normalization, and we would anticipate only one or two further rate hikes this year. While we think left tail risks will remain a significant concern for investors this year, there will also be attractive investment opportunities generated by the market disarray”, concludes Rick Rieder, Chief Investment Officer Global Fixed Income BlackRock e Co-Manager BlackRock Fixed Income Global Opportunities.

Source: Rick Rieder, Chief Investment Officer Global Fixed Income BlackRock e Co-Manager BlackRock Fixed Income Global Opportunities