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Anticipating the Fed

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Since March of this year Federal Reserve Chair Yellen has been alluding to a rate increase “later this year”, but thus far has been unable to justify one.

“That’s—that is, you know, a reason that many of my colleagues—most of my colleagues—are anticipating that it will be appropriate to begin to tighten policy sometime this year.”
— March 18, 2015 Chair Yellen’s Press Conference
“It’s not an ironclad guarantee, but we anticipate that that’s something [a rate increase] that will be appropriate later this year.”
— June 17, 2015 Chair Yellen’s Press Conference
“You know, I have characterized the Committee view as, you know, a forecast that will likely, if it prevails, if that’s how the economy evolves, call for a funds rate increase later this year.”
— September 17, 2015 Chair Yellen’s Press Conference

And now the Fed meets again October 27 and 28, and one last time this year December 15 and 16. So, will the Fed raise rates? Should they? With a 0% Fed Funds rate for so long, I venture to suggest that the majority of us don’t give much thought to the potential of a .25% rate hike. Rather, the real question on everyone’s mind is what happens to the market if they do or don’t?

Consider the September meeting when, leading up to the Fed’s decision, the talking heads on TV provided us with enough drama and conjecture that we were somehow convinced this was it—this was the meeting when the inevitable rate hike takes place, and it was bad. The S&P 500 sold off 5% in the 30 days leading up to the FOMC meeting. Then the big meeting took place and the Fed left rates alone. Good, right? Wrong. The S&P 500 sold off another 5.5% in the 10 days following the FOMC meeting, this time because we were convinced the economy was too sick and couldn’t handle a rate hike.

So, do we want rates to go up or to stay the same? Our answer: Yes, as long as the data behind the decision supports it. The Fed needs to stop suggesting its rate decisions depend on a Gregorian calendar, and just focus on the data. And the data doesn’t support a rate hike just yet. Since the last FOMC meeting:

  • the Manufacturing Index has slowed by 2%
  • the Service Index has slowed by 3.5%
  • 3 month average jobs growth slowed from over 220,000 to under 170,000
  • exports have dropped by 2%
  • excluding auto sales, retail sales have dropped .3%
  • housing permits have dropped nearly 5%

If the Fed passed on rate hikes all year based on economic data that didn’t support them, then raising rates now in light of even weaker data would be completely inappropriate.

What does all this mean for the markets? In the long run, not much. In the short term, ongoing volatility, but we expect to see a continued upward trend through it all. We’re likely in the later stages of the Bull market, but we look for more room to run. With that in mind, monitoring quality and risk is important in times like this. As was suggested in the first FNA newsletter of the year, comparing your portfolio returns to the S&P 500 or other broad market index is only appropriate if you’re willing to take that same level of risk on the downside. Markets can’t be timed, so be prudent and be aware of the risk associated with your portfolio. Reach out to us if you have any questions or concerns.

Sources: CNBC.com and Morningstar.com

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