Content provided by Marc Pfeffer, CLS Senior Portfolio Manager
The Fed is losing patience, but they won’t be “impatient” …
That is essentially how Fed Chair Janet Yellen began the Federal Open Market Committee’s (FOMC) news conference on March 18. While there was much market chatter leading up to the conference, the most significant announcement was largely anticipated and caused little upheaval. The FOMC removed the word “patient” from its policy statement. As I said to USA Today prior to the conference, “While removing the word ‘patient’ does open the door, in my opinion that is the most certain outcome expected from the meeting.”
Removing the word ‘patient’ does not mean the Fed will raise rates sooner, or quite frankly, at all. The revised statement simply alerts the market that it may raise rates.
While the market anticipated the Fed’s change, it did not predict the patience to manifest itself as much as it did in the Survey of Economic Projections (SEP). Not only were growth and inflation projections revised down, but the interest rate projections of the Federal Reserve Governors, as represented by the published dot plot, shifted down by 50 bps at the end of 2015, and by a similar amount for 2016 and 2017, (the dots moved closer to CLS’s own internal survey from its portfolio management team). Moreover, the median NAIRU (non-accelerating inflation rate of unemployment) estimate was lowered – a clear case of moving the goalposts and a sign of a dovish Fed.
The FOMC’s statement also mentioned that growth had moderated somewhat, but the main motivation for more dovish projections was clearly the exchange rate. This was not lost on the market with EUR/USD exchange rate moving from 1.05 to nearly 1.10. A huge move! The closer EUR/USD trades to parity, the greater the risk that the rate hike will be delayed further, despite 15 out of 17 members on the FOMC signaling they see a 2015 liftoff.
For now, the Fed has a tricky balancing act to perform – how to prepare the domestic markets for the (inevitable) rate hike without the currency market (FX) taking the USD too high, too fast.
In the meantime, CLS will be watching the labor market – as most of the recent economic data has been below expectations and growth forecasts are being revised lower – to gauge its impact on inflation expectations. In terms of fixed-income positioning and CLS’s outlook, we continue to be somewhat shorter in duration, more neutral between credit and government-backed securities, and we expect muted returns in fixed-income in 2015.