Is the market too fearful of the Fed?

Thought of the day

by Chief Investment Office 22 Feb 2018

The value of both bonds and equities fell after the release of the minutes from the January Federal Open Market Committee (FOMC) meeting on 21 February. Yields on 10-year US Treasuries gained as much as six basis points to hit 2.95%, a fresh four-year high, and the S&P 500 reversed earlier gains to close 0.55% lower.

But while the market reaction reflects ongoing concerns about the potential for higher inflation and faster tightening, we see reasons why investors shouldn’t be alarmed.

  • Scrutiny of the FOMC’s language is always intense and the sentence, “further gradual policy firming would be appropriate” appears to have contributed to the market reaction. But Minneapolis Fed President Neel Kashkari said that, “we debate each word change in the statement…and I think 'further' was intended to say continuing the current path we’re on.”
  • Nevertheless, the Fed’s language appears more optimistic on growth and inflation. Given the recently announced fiscal stimulus, the Fed’s March projections will likely show higher growth and inflation and a higher “dot plot.” But this should only bring the FOMC into line with our forecasts for four hikes in 2018 and three in 2019.
  • With real yields at the top of their trading range since 2013, inflation breakevens close to the Fed’s target of 2%, and with ongoing structural demand for bonds from institutional buyers, we believe the bulk of the increase in US 10-year yields is over.

So, in our view, a further significant increase in yields would likely not be fundamentally justified, and we expect equities to benefit from higher growth expectations. We remain overweight global equities.

Do you like this?

Please click below to sign up for more investment views.