Pacific Funds, June 2017

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

As expected, the Federal Open Market Committee (FOMC) raised the target range for the federal funds rate by 0.25% to 1.00%–1.25%. This is the fourth rate hike from the Federal Reserve (Fed) in the past 18 months and third hike in the past six months. Median expectations are for the Fed to raise interest rates once more in 2017. Economic expectations were also updated, with the median “dot plots” remaining mostly unchanged. There were no major revisions to the median estimates for gross domestic product (GDP), but language pertaining to inflation was dovish, with inflation projections being revised lower. In addition to economic projections, the Fed issued an addendum regarding its’ balance sheet. Below are some of our notes:

  • The FOMC increased the range for the federal funds target rate to between 1.00% and 1.25%.
  • Language changes in the June press release (shown in italics) were not significant:
    • Economic activity has been rising modestly so far this year, versus slowed in May [a hawkish change].
    • Household spending has picked up in recent months, and business fixed investment has continued to expand, versus rose only modestly in May [a hawkish change].
    • Inflation has declined recently and, like the measure excluding food and energy prices, is running somewhat below 2 percent, versus has been running close to the Committee’s 2 percent in May [a dovish change].
    • Inflation on a 12-month basis is expected to remain somewhat below 2 percent in the near term, versus inflation will stabilize around the 2 percent objective in May [a dovish change].
    • Language added was: The Committee currently expects to begin implementing a balance sheet normalization program this year, provided that the economy evolves broadly as anticipated, versus removal of language keeping the Committee’s holdings of longer-term securities at sizable levels, should help maintain accommodating financial conditions in May [a hawkish change].
  • Median dot plots remain unchanged for 2017. Four dots suggest no more rate increases in 2017, eight reflect one more hike, and four reflect two additional hikes.
  • Going forward, median expectations are suggesting an ending target rate of 1.375% in 2017 (one hike), 2.125% for 2018 (three additional hikes), 2.875% in 2019 (three additional hikes), and 3.0% for the longer run.
  • Economic projections were mixed, with real GDP revised higher by 0.1%, to 2.2%, and unchanged in 2018 and 2019 at 2.1% and 1.9%, respectively.
  • Longer-run unemployment was revised modestly lower to 4.6% from 4.7%.
  • Finally, the core personal consumption expenditures (PCE) price index for inflation was revised lower to 1.6% from 1.9% for 2017, and maintained at 2.0% for both 2018 and 2019.
  • Federal funds futures, as forecast by Bloomberg, currently show a 28% chance of an interest-rate hike to be announced during the September 2017 meeting.1
  • There was only one dissenting vote—Minneapolis Federal Reserve President Neel Kashkari—who voted to keep rates unchanged.

In addition, the Fed released the following in the Addendum to the Policy Normalization Principles and Plans. Essentially, it provides more detail on the pace of reduction for the balance sheet. It does not, however, suggest when this will begin. The press release does mention the expectation to begin this process sometime in 2017.

  • The Committee intends to gradually reduce the Federal Reserve’s securities holdings by decreasing its reinvestment of the principal payments it receives from securities held in the System Open Market Account. Specifically, such payments will be reinvested only to the extent that they exceed gradually rising caps.
    • For payments of principal that the Federal Reserve receives from maturing Treasury securities, the Committee anticipates that the cap will be $6 billion per month initially and will increase in steps of $6 billion at three-month intervals over 12 months until it reaches $30 billion per month.
    • For payments of principal that the Federal Reserve receives from its holdings of agency debt and mortgage-backed securities, the Committee anticipates that the cap will be $4 billion per month initially and will increase in steps of $4 billion at three-month intervals over 12 months until it reaches $20 billion per month.

 

Market response

Markets have shown little reaction to the rate increase, which was largely priced in. Despite the increase in the target rate and expectation of balance sheet reduction, the Fed continues to be accommodative with monetary policy as it moves toward normalization. Market participants seem focused on fiscal and regulatory policy at this point in time, as those policies appear to be more uncertain.

 

1Bloomberg Finance L.P., June 26, 2017.


Definitions

Hawkish refers to an indication the Federal Reserve may raise 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 Federal Reserve’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 as of June 2017, are based on current market conditions, and are subject to change without notice. These views represent the opinions of the portfolio managers at Pacific Asset Management 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 ormake 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.