The September FOMC meeting ended on September 21 with no action. Here’s our take on it: The 'hawks' hoping for a rate increase were disappointed, but it wasn’t really a surprise for most. Three members of the Fed wanted a rate hike now—and the statement alluded to a rate hike being likely in the near future, after “further evidence of continued progress towards its objectives.” The stock markets, on the other hand, liked the Fed’s decision. The base case still appears to be a single rate hike in December, although these rate increases continue to be pushed out so often, a deferral to 2017 wouldn’t surprise us. We wish we had a way of making these mandate items more interesting, but much of the narrative and themes are little changed from the prior meeting. Here are the three big factors:
1) Economic growth continues to run at a generally lackluster pace, although we may see some improvement in Q3-Q4 from inventories, a tick upward in energy sector projects as oil prices have recovered, and other effects. Smoothing things out, GDP growth for 2016 looks to be at a just under 2%.
2) Inflation also remains stubbornly low (for policymakers), although most consumers and businesses have far fewer complaints about low inflation than they do slow economic growth. The Consumer Price Index (CPI), including the volatile energy prices, is at about +1.1% on a trailing 12-month basis, while core inflation has been running closer to the Fed’s target at +2.3%. Some of the latter has been due to higher costs in healthcare services, but mostly by higher rents and real estate prices.
3) Employment continues to be the most positive aspect of the recovery thus far. Attention has turned to ‘How much stronger can we get from here?’ and the answer is: ‘Hard to say, but perhaps not much.’ In fact, some data, such as the Fed’s relatively new labor market indicator, have begun to peak and trail off, which either could be a temporary phenomenon due to a data quirk or a more significant sign of a change in the cycle. The Fed has been hoping for signs of better wage growth, but there hasn’t been much of that happening except in a few specialized jobs.
If the Fed had gone the other way, we could have seen an equal—but temporary—drop in the major stock market indexes. As we have written several times over the past two years, it takes much more than just a 0.25% interest rate increase to derail equities into a bear market. Based on past history, rates would need to increase by at least two to four full percentage points to have a major long-term effect on the stock markets.