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The Fed’s Flexibility


In the last month, we have seen massive risk-off maneuvering in which re-calibration toward potential slower growth and increased legislative constipation from the midterm results has ground positive momentum to a grinding emotional halt. The U.S. 10-year Treasury yield has declined from 3.24% in the beginning of November to a current 2.84%. A decline of 40 bps (basis points) has also resulted in an increase in price of roughly 3.50%. Despite that gain, the overall U.S. Treasury Bloomberg Index is still down year to date.

This has had a prominent impact on future rate hikes. As shown by Bloomberg’s Chief Economist Michael McDonough, we not only have seen the probability for a rate hike at the December 18 and 19 meetings decline from 80% to 68%, all implied rate hikes next year have a below 50% of occurring. In simple terms, the market is saying that the Federal Reserve will be in a wait-and-see mode or data dependent about future hikes. This is also being corroborated by reports out of several regional Federal Reserves.

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Source: Bloomberg

The Atlanta Federal Reserve President Raphael Bostic said, “Given the current constellation of strong growth, very low unemployment rates and inflation close to two percent…monetary policy ought to be taking a more neutral position.” President Bostic continued, “That said, should the data deliver clearer signals of either, I would be fully prepared to support policy actions to mitigate the risks in either direction.”

Dallas Federal Reserve President Robert Kaplan also seemed to confirm the idea of not being set on a path of rate hikes. “I think there’s more uncertainty, global growth’s decelerating. I’m seeing interest rates showing some weakness. It’s too soon to say what to make of it. But I think one of the key tools we have with central banks is patience, and I think we ought to start using that tool.”

Considering that, it is very important to remove the binary frame of mind when it comes to the Federal Reserve’s history. That is, history shows the FOMC (Federal Open Market Committee) is not in a historical pattern of hiking rates until a recession begins and conversely, lowering rates until an expansion takes hold.

In the history of the Fed Funds Rate, we have seen clear patterns to the FOMC shifting propensities mid-stream. The two longest expansions in the last 50 years show a clear-cut pattern of raising rates, lowering rates and ultimately raising rates again until the next recession began.

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Concluding that a flexible Federal Reserve may elongate economic expansions seems too shallow an answer for a far deeper question. We also must take into consideration that the rate hike trajectory of the last three years is the most anemic on record. All things considered, it is important not to be stuck in such a binary frame of mind when it comes to the markets and economics that drive it. All events and narratives derived, touched and recalled by people are malleable and morph over time, but reviewing historical data can often add much-needed context.

 

CRN: 2018-1204-7086R

This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the Disclosures webpage for additional risk information at commentary-disclosures. For additional commentary or financial resources, please visit www.aamlive.com.

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Effective, June 10, 2016, please note that Gene Peroni left Advisors Asset Management (AAM) to become President of Peroni Portfolio Advisors, Inc. Peroni Portfolio Advisors, Inc. ("PPA") is an investment advisor independent of AAM.

 

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