Pacific Funds, August 2016
The Federal Reserve (Fed) took a hawkish turn when it released the July statement from the Federal Open Market Committee (FOMC). Pacific FundsSM portfolio managers discuss key points from a fixed income, asset allocation, and equity perspective, as well as potential implications through the remainder of 2016.
Pacific Asset Management, manager of Pacific FundsSM Fixed-Income Funds
- The FOMC decided to maintain the target range for the federal funds rate at 0.25% to 0.50%.
- Language changes were minimal, but important, with a hawkish tilt such as:
- “Near-term risks to the economic outlook have diminished”
- July: The labor market strengthened versus June: The labor market has slowed.
- July: Economic activity has been expanding at a moderate rate versus June: Economic activity appears to have picked up.
- July: Job gains were strong in June following weak growth in May versus June: Unemployment rate has declined, and job gains have diminished.
- July: Household spending has been growing strongly versus June: Growth in household spending has strengthened.
- Fed fund futures implied that the probability of a rate hike in 2016 was approximately 46% at the start of second quarter, which is much higher than at the end of June, when it stood at 9.8%.
Due to the nuanced changes in language, in our opinion, it appears the Fed is setting up a rate hike for December, assuming data is not overly strong for a September rate hike, nor overly weak to remain through the year.
Pacific Life Fund Advisors LLC, investment adviser to Pacific FundsSM Portfolio Optimization Funds and Pacific FundsSM Diversified Alternatives
- Market sentiment shifted from an 88% probability of no hikes on July 1 to just under a 50% probability of a single hike in 2016.
- “Near-term risks to the economic outlook have diminished,” as stated by the Fed, which means rate hikes are back on the table; but remember that hawkish statements in May evaporated under a hiccup in employment figures and Brexit.
- The Fed referenced that risks were "balanced" prior to last December's rate hike:
- The U.S. is at or very close to full employment and the economy is on solid footing.
- The labor force participation rate appears to have bottomed out.
- The FOMC noted that “Household spending has been growing strongly but business fixed investment has been soft.”
- Manufacturing and services still expansionary, even if "soft"
- However, there are increasing signs of late-cycle behavior:
- Employment growth is decelerating.
- Vehicle sales are off their peaks.
- Corporate profits are off peak levels.
As a result, faced with an economy in late expansion and a Federal Reserve that will potentially be forced to raise rates, we are more defensive in our positioning and are cognizant of the risks that a rising U.S. dollar could create if the Fed were to raise interest rates.
Rothschild & Co Asset Management US Inc., subadvisor to Pacific FundsSM U.S. Equity Funds
- As widely expected, the FOMC kept rates on hold.
- Also as expected, the statement contained a few changes that suggested the FOMC had become less cautious since the June meeting, acknowledging the recent rebound in payrolls and consumer spending data. Overall, the Fed believes near-term risks to the economic outlook have diminished.
- That said, a rate hike at the September 21 meeting remains highly unlikely. In the recent past, FOMC communication tended to be more explicit in signaling the possibility of a rate hike at the subsequent meeting. Furthermore, the statement stopped short of saying that the risks to the outlook were nearly balanced, which would be a precondition to further policy tightening.
- Because interest rates already are low, the Fed has little room to ease conditions if growth falters; hence, it will be easier to respond to faster inflation than to an economic downturn.
- In the end, the Fed will only start its monetary normalization when it has seen further improvement in the labor market and is reasonably confident that inflation will move back to its 2% objective over the medium term. In that regard, a rise in interest rates by year's end (December 2016) seems likely. However, beyond the date of the next interest-rate increase, the amplitude and duration of the cycle of monetary normalization has much more importance from a macroeconomic perspective. On this point, the Fed will remain very patient.
While FOMC decisions are watched closely by many, they do not have a significant impact on the way we manage the funds. Rather than focusing on interest rates or any other macroeconomic changes, we remain bottom-up investors, seeking stocks with attractive valuations and the potential to exceed expectations.
This commentary reflects the views of the portfolio managers through 08/02/2016. Rothschild & Co Asset Management US Inc.’s, Pacific Asset Management's, and PLFA’s views are subject to change as market and other conditions warrant. No forecasts are guaranteed. This commentary is provided for informational purposes only and is not an endorsement of any security, mutual fund, sector or index. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.
Rothschild & Co Asset Management US Inc. is unaffiliated with Pacific Life Insurance Company.
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Pacific Life Fund Advisors LLC (PLFA), a wholly owned subsidiary of Pacific Life Insurance Company, is the investment adviser to Pacific Funds Portfolio Optimization and is responsible for determining the asset allocation mix for each portfolio. PLFA also does business under the name Pacific Asset Management and manages certain portfolios under that name.
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