13 December 2018

The Fed Stays The Course On Interest Rates

#
Share This Story

The Federal Reserve stayed the course on interest rates last week. Given strong economic activity, more rate hikes could be ahead in December or in 2019. Below is a synopsis of the Fed's comments and my interpretation.

Fed's Comments 

In view of realized and expected labor market conditions and inflation, the Committee decided to maintain the target range for the federal funds rate at 2 to 2-1/4 percent.

My Interpretation:

The Fed has instituted eight quarter-point rate hikes since December 2015. No one expected Fed Chairman Jerome Powell to hike rates during mid-term elections that saw the Democratic party retake the House of Representatives. However, the Fed continues to unwind its balance sheet and gradually remove stimulus measures built up over the past decade. At the end of October, the Fed had $4.1 trillion in assets, down from $4.5 trillion two years earlier.

The October jobs report continued to show signs of a white-hot economy. Jobs grew by 250,000 and unemployment was 3.7 percent, down from 4.1 percent in the year earlier period. Unemployment remains well below the 5 percent level considered full employment - low enough to create inflationary pressures.

Fed's Comments 

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee expects that further gradual increases in the target range for the federal funds rate will be consistent with sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee's symmetric 2 percent objective over the medium term. Risks to the economic outlook appear roughly balanced.

My Interpretation:

Unemployment has not consistently been at or below 4.0 percent since late 2000. Rates this low portend the ability of workers to demand higher wages from current employers or garner higher wages by switching jobs. Average hourly wages were $27.30 in October; this was up 3.1 percent Y/Y, and followed a 2.8 percent rise in September. The metric fanned fears of more interest rate hikes and caused the yield on 10-year treasuries to rise to 3.22 percent.

The Dow Jones fell over 200 points Friday to just under 26,000. It was at around 26,500 when the Fed last hiked rates in September. Last month, President Trump has intimated there is no need for more rate hikes and blamed the September rate hike for causing stock market volatility. October's figures on wage growth and unemployment will likely lead to more rate hikes and even more stock market volatility.

Fed's Comments 

In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its maximum employment objective and its symmetric 2 percent inflation objective. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments.

My Interpretation:

The Fed uses personal consumption expenditures, excluding food and energy ("PCE"), as its inflation measure. The Fed's target for PCE growth is 2 percent. PCE growth was 1.9 percent in Q2 2018 and 2.0 percent in Q3 2018. After trillions in stimulus, PCE growth has finally met the Fed's target. It could be warranted for Powell to hike rates a few more times to avoid runaway inflation.

Former Fed Chairman Ben Bernanke wanted to keep rates low and to help spike asset prices and put assets on individuals' balance sheets. In my opinion, a Dow near 26,000 is the result of that policy. If Powell continues to remove the punch bowl via more rate hikes, then stock market volatility could be a way of life for investors.

With 10-year treasuries below 4 percent, I do not believe equity investors should panic. However, it is likely a stock picker's market. Traditional metrics, like earnings multiples and EBITDA multiples, could come back into vogue.

Conclusion 

The bull market for stocks is likely intact. However, highly indebted names or companies that trade at unusually high multiples of earnings or EBITDA could be vulnerable.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Click here for the original article.  

Join Our Online Community
Join the Better Way To Retire community and get access to applications, relevant research, groups and blogs. Let us help you Retire Better™
FamilyWealth Social News
Follow Us