Pacific Funds, MARCH 2018

Informational commentary from Pacific Asset Management, manager of Pacific FundsSM Fixed-Income Funds.
 

In one of the more eagerly anticipated meetings since the interest-rate hiking cycle began two years ago, the Federal Open Market Committee (FOMC) voted to raise the target range for the federal funds rate by 25 basis points (one basis point is equal to 0.01%) to between 1.50% and 1.75%. While the rate increase was fully priced in prior to the decision, investors were looking for indications of future rate hikes. In particular, would the Federal Reserve (Fed) meeting statement or “dot plots” indicate three or four total rate increases in calendar year 2018? There were minor adjustments to the language in its statement, which are noted below:

  • The FOMC raised the range for the federal funds target rate to between 1.50% and 1.75%.
  • Language changes in the March statement (shown in italics) were minimal, and consistent with further rate hikes:  
    • Economic activity has been rising at a moderate rate, versus a solid rate (net dovish).
    • Job gains have been strong in recent months, and the unemployment rate has stayed low, versus job gains have remained solid and the unemployment rate stayed near its recent low. Recent data suggest that growth rates of household spending and business fixed investment have moderated from their strong fourth-quarter readings, versus have been solid (net dovish).
  • While the median dot-plot forecast still reflects two additional hikes in 2018, the average of the dots was about 18 basis points higher, which is much closer to indicating three more hikes this year. 
  • Going forward, median expectations suggest a target rate of 2.125% for 2018 (two additional hikes), 2.875% in 2019 (three additional hikes), 3.375% in 2020, and 2.875% for the longer run. 
  • Economic projections were mixed, with real gross domestic product (GDP) revised modestly higher by 0.2% to 2.7% in 2018, by 0.3% to 2.4% in 2019, unchanged at 2.0% in 2020, and 1.8% for the longer run.
  • Unemployment rates have been revised downward to 3.8% for 2018, 3.6% for both 2019 and 2020, and 4.5% for the longer run. 
  • The core personal consumption expenditures (PCE) price index for inflation was maintained at 1.9% for 2018, and increased modestly to 2.1% for 2019 and 2020.
  • Federal funds futures, as forecast by Bloomberg, currently show a 30% chance of an interest-rate hike to be announced in the May 2018 meeting.1
  • Voting for the FOMC monetary policy action were Jerome H. Powell, Chairman; William C. Dudley, Vice Chairman; Thomas I. Barkin; Raphael W. Bostic; Lael Brainard; Loretta J. Mester; Randal K. Quarles; and John C. Williams. 
 
Looking Forward

In his press conference, Jerome Powell communicated that the U.S. should focus on productivity and labor participation. When discussing the decision, he stated that the committee members, while divided on their thoughts for the current year, see a meaningful increase in demand from new fiscal policy, which may take time to be reflected in growth and inflation readings. Additionally, they believe the benefits of supply-side effects as well as higher investment by companies should drive productivity. Finally, the Fed expects to see labor-supply effects in light of lower tax rates. On balance, however, while the market appears to be digesting the Fed’s decision, it appears to be cautious with respect to trade implications with China. Overall, these should be supportive of growth for the U.S. and its corporations. 

 
Market Response

Overall, this rate hike passed with little reaction from the markets as both equity and bond markets priced the increase into current valuations. The yield curve ended largely unchanged on the day, while initially steepening on the decision. Despite relative soft language changes, Fed watchers certainly have a case for more than three hikes in 2018 given the recent tax cuts and expected government spending increases. To note once again, while median forecasts indicate two more hikes in 2018, the average was very close to indicating three more hikes this year. While higher interest rates should widen risk premiums, we continue to believe that U.S. corporate-credit-based fixed income continues to provide an attractive destination for both domestic and international investors searching for yield. 

 

1Bloomberg Finance L.P., 3/21/18.


Definitions

Dovish refers to an indication the Fed may lower interest rates.

A dot chart or "dot plot" is a statistical chart consisting of data points plotted on a fairly simple scale used to project the rate path.

Core personal consumption expenditures (PCE) price index is the Fed’s preferred measure of U.S. inflation, which measures the prices consumers pay for goods and services without the volatility caused by energy and food prices.


Disclosures

This publication is provided by Pacific Funds. Pacific Funds refers to Pacific Funds Series Trust. This commentary reflects the views of the portfolio managers at Pacific Asset Management as of March 21, 2018, are based on current market conditions, and are subject to change without notice. These views represent the opinions of the portfolio managers and are presented for informational purposes only. These views should not be construed as investment advice, an endorsement of any security, mutual fund, sector, or index, the offer or sale of any investment, or to predict performance of any investment. Any forward-looking statements are not guaranteed. All materials are compiled from sources believed to be reliable, but accuracy cannot be guaranteed.

All investing involves risk, including the possible loss of the principal amount invested.

Pacific Life Insurance Company is the administrator for Pacific Funds. It is not a fiduciary and therefore does not give advice or make recommendations regarding insurance or investment products.

PLFA3

Pacific Life Fund Advisors LLC (PLFA), a wholly owned subsidiary of Pacific Life Insurance Company, is the investment adviser to the Pacific Funds. PLFA also does business under the name Pacific Asset Management and manages certain funds under that name.

Bloomberg Finance L.P. is unaffiliated with Pacific Life Insurance Company, Pacific Funds, their affiliates, their distributors, and representatives.