Fed's consistent tone soothes inflation concerns

Thought of the day

by Chief Investment Office 24 May 2018

Political issues have continued to grab the headlines this week – from fresh trade concerns as the Trump administration shifted focus onto US vehicle imports and announced new sanctions on Venezuela, to the formation of an anti-establishment coalition government in Italy.

But against this backdrop, the Federal Reserve is a reassuring voice. Yesterday’s release of the minutes from the 2 May Federal Open Market Committee (FOMC) meeting offered support to our view that rising inflation won’t prompt a faster pace of rate increases that could hurt risk assets.

  • The Fed appears comfortable with inflation overshooting its 2% target. The minutes noted that “a temporary period of inflation modestly above 2 percent would be consistent with the Committee’s symmetric inflation objective and could be helpful in anchoring longer-run inflation expectations at a level consistent with that objective.”
  • Wage pressures are contained. Many FOMC participants commented that the pressures were still moderate, and several noted that recent wage developments provided little evidence of general overheating in the labor market.
  • The Fed added to the impression that it is in no hurry to raise rates more quickly, noting concerns among its business contacts about the possible adverse economic effects of tariffs, including on capital spending.

Overall the Fed gave the impression that there is little need to increase the current pace of tightening, which was reflected in the bond market’s reaction. US 2-year yields fell nearly 7bps from their pre-minutes session peak, while US 10-year yields dipped below 3% after the release. We expect one 25bp rate hike per quarter this year, and remain overweight 10-year US Treasuries and overweight global equities.

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