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.
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