Market Commentary - 10.27.14 All Eyes on the Federal Reserve This WeekThe Federal Reserve takes center stage as its Federal Open Markets Committee (FOMC) meets Tuesday and Wednesday with a policy announcement due at the conclusion of Wednesday's meeting. While most FOMC meetings are important to investors, given the fact that the FOMC is widely expected to wrap up its long-running bond purchasing program (quantitative easing), the fact that changes are coming in the composition of the committee, and the recent increase in market volatility, this week's meeting has added significance.
The FOMC meets eight times a year in order to determine the near-term direction of monetary policy. In evaluating its monetary policy, the FOMC assesses the relative concerns over the outlook for economic growth and future inflation. The FOMC then determines whether short-term interest rates should be raised, lowered, or left unchanged to accomplish its dual objectives of maintaining healthy economic growth and low inflation. The interest rate set by the Fed serves as a benchmark for all other rates. While every FOMC meeting is important as the financial markets look for clues as to the timing and trajectory of interest rate hikes, this week's meeting offers greater significance for the following reasons:
- Since last December the Fed has been gradually scaling back its monthly bond purchases by $10 billion each month. The amount of purchases now stands at $15 billion per month, but Fed policy makers have indicated they will phase out the entire amount at this meeting. Given the recent mixed readings on the U.S. economy (for example, labor markets continue to improve but readings on manufacturing and the consumer have been weak), there is uncertainty regarding whether or not the economy can stand on its own two feet without QE. Comments related to QE will be extremely important.
- There has been huge debate (via recent speeches of FOMC members) regarding the direction of interest rates. Hawks believe the economy is strong enough and want to start raising interest rates sooner. Doves feel the opposite. In 2015, two significant hawks on the FOMC are set to retire (Charles Plosser and Richard Fisher). This could be one of their last chances to assert their hawkish tone to other FOMC members. In particular, the big question is whether the FOMC will alter the language of its statement to eliminate the phrase "for a considerable period,"쳌 which has been used to describe how long rates will remain low after quantitative easing ends.
- Lastly, investors will look for any FOMC comments regarding current market issues including Europe's slowdown, the recent weakness in oil prices and associated inflation ramifications, and the strength of the US dollar. Many of these have contributed to the recent elevation in market volatility.
Overall, having learned from past FOMC mistakes, today's FOMC has been very good at articulating their plans and carefully wording their intentions. We do not expect too many surprises by the Fed and agree with the consensus that the Fed will not likely raise interest rates until the second or third quarter of next year. Inflation remains benign, allowing the Fed to be patient and not necessarily needing to raise interest rates anytime soon. Furthermore, U.S. growth will likely continue on its trend-like and low inflation friendly, three percent growth for the foreseeable future. Despite some blips, consumer spending and manufacturing remain solid. The contraction in government spending should reverse soon and may be a tailwind to economic growth.
While every FOMC meeting is important to the direction of the financial markets, this week's meeting offers added significance given the expected conclusion of QE, increased debate among its members, and the increase in concerns driving the market. Regardless of FOMC decision and comments, we expect the jittery market to remain volatile as investors balance the merging of headwinds and tailwinds. From an investment standpoint, we remain committed to a portfolio that is more diversified than normal, U.S. equity biased, and, with bond yields near historic lows, braced for any potential rise in interest rates. This information is compiled by Cetera Investment Management.
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