The Fed Finally Raises!
At long last, the Federal Reserve increased interest rates citing a variety of factors suggesting that the US economy has stabilized and is expanding. However, what traders and market watchers were most anticipating was the forward-looking guidance provided by Janet Yellen and the Policy Committee. Here are several excerpts from their notes released yesterday that are most telling about the perspective of the Federal Reserve as it relates to interest rates and the change trajectory we can expect going forward.
- ‘The Committee judges that there has been considerable improvement in labor market conditions this year and it is reasonably confident that inflation will rise, over the medium term, to its 2% objective.'
- 'The Committee currently expects that, with gradual adjustments in the stance of monetary policy, economic activity will continue to expand at a moderate pace and labor market indicators will continue to strengthen. Overall, taking into account domestic and international developments, the Committee sees the risks to the outlook for both economic activity and the labor market as balanced.'
- 'The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.’ Source: http://www.federalreserve.gov/newsevents/press/monetary/2015monetary.htm
Note their emphasis on the word “gradual". This is why the market rallied; investors were looking to see if this was the beginning of a strong push forward up in the direction of rates. It’s fairly clear from the statements made by the Federal Reserve that this will likely not be the case.
Why We Believe Rates Will Not Rise Rapidly
We believe there are 5 reasons why rates will not rise quickly:
- Softness in the labor participation rate
- A global environment focused on lower rates
- Continuing challenges in emerging market economies
- Low inflation related to collapsing energy prices
- The need to depress US currency to remain competitive in the global marketplace
The bottom line for the Federal Reserve is that they are stuck in a policy corner and cannot raise rates significantly. Mortgage defaults would skyrocket if rates suddenly ramped up quickly and exports from the United States to other countries would suffer greatly if rates increased in any significant way.
As I have stated over the course of the last month, it is our view that rates will remain low for a significant period of time and DWM investment strategy factors in that perspective. What this means for portfolio strategy is that income-oriented assets will likely not suffer disastrous losses as feared by some. We have already increased duration slightly in fixed assets. Our dividend rate remains significant and is a core part of how we invest. While we will have limited international assets in portfolios, they are underweight in normal long-term allocation levels and we expect that to continue for the foreseeable future.
We’ve already begun to make changes towards the strategy I have outlined over the course of the last month and will continue moving forward with that process. I’m happy to discuss our strategy with you personally either by email or phone. Just let me know; I’m happy to chat.