Pacific Funds, September 2017
Informational commentary from Pacific Asset Management, manager of Pacific FundsSM Fixed-Income Funds.
As expected, the Federal Open Market Committee (FOMC) voted unanimously to maintain the target range for the federal funds rate at 1.00%–1.25% amid improved economic conditions in the U.S. Economic expectations were also updated, with the median “dot plots” mostly unchanged in the near term, which reflects a potential shift towards tightening financial conditions without as much emphasis on raising interest rates over the longer term. Median expectations for the Federal Reserve (Fed) to raise interest rates once more in 2017 remain mixed, with a 60% probability of a December hike priced into the markets.1 The primary change is the Fed’s announcement to begin reducing its portfolio of Treasury and mortgage-backed securities beginning in October. Below are some of our notes:
- The FOMC maintained the range for the federal funds target rate at between 1.00% and 1.25%.
- Language changes in the September press release (shown in italics) were not significant:
- Job gains have remained solid in recent months, versus have been solid, on average, since the beginning of the year.
- Unemployment rate has stayed low, versus has declined.
- Household spending has been expanding at a moderate rate, and growth in business fixed investment has picked up in recent quarters, versus household spending has picked up in recent months, and business fixed investment have continued to expand.
- Language added included the following:
- Hurricanes Harvey, Irma, and Maria have devastated many communities, inflicting severe hardship. Storm-related disruptions and rebuilding will affect economic activity in the near term, but past experience suggests that the storms are unlikely to materially alter the course of the national economy over the medium term.
- Higher prices for gasoline and some other items in the aftermath of the hurricanes will likely boost inflation temporarily; apart from that effect, inflation on a 12-month basis is expected to remain somewhat below 2 percent in the near term but to stabilize around the Committee’s 2 percent objective over the medium term.
- In October, the Committee will initiate the balance sheet normalization program described in the June 2017 Addendum to the Committee’s Policy Normalization Principles and Plans.
- Median dot plots remain unchanged for 2017, with 11 officials expecting one more hike this year, four suggesting no more rate increases, and one reflecting two additional hikes.
- Going forward, median expectations suggest an end of year target rate of 1.375% for 2017 (one hike), 2.125% for 2018 (three additional hikes), 2.625% in 2019 (three additional hikes), and 2.75% for the longer run.
- Economic projections were mixed, with real GDP revised higher by 0.2% to 2.4% in 2017, by 0.1% to 2.0% in 2019 and unchanged at 2.1% for 2018 and 1.8% for the longer run.
- Unemployment rates remained the same at 4.3% for 2017 and 4.6% for the longer run but were revised downward modestly to 4.1% for 2018 and 2019.
- Finally, the core personal consumption expenditures (PCE) price index for inflation was maintained at 1.6% for 2017, 2.0% for 2019, and 2.0% for the longer run but was revised downward modestly to 1.9% for 2018.
- Federal funds futures, as forecast by Bloomberg, currently show a 60% chance of an interest-rate hike to be announced during the December 2017 meeting.2
In addition, the Fed provided information as to the timing of the initial reduction of the balance sheet, which is currently over $4 trillion.
- 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.
Markets have again shown little reaction to the interest-rate decision, which was largely priced in. Bond yields rose slightly across the curve in a relatively symmetrical fashion following the announcement. Despite the surge in gasoline prices in August, and as expected, there were no major changes to the Fed’s preferred inflation measure, the personal consumption expenditures (PCE) price index, which excludes food and energy. Core PCE, which rose 1.4% in July, the smallest year-over-year increase since December 2015, has consistently undershot the Fed’s 2.0% inflation target since mid-2012.
Overall, we believe the announcement is unlikely to have a significant impact on financial markets as the limits set by the Fed in its addendum are small compared to the size of its balance sheet, requiring some time before the balance sheet returns to levels in 2008 when the Fed began purchasing U.S. government-backed securities.
With respect to fixed-income, our outlook for credit remains constructive. And while credit spreads remain tight, we believe they reflect a stable fundamental backdrop for corporations.
1Bloomberg Finance L.P., September 20, 2017.
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, which is released along with the Fed’s policy decision statement. Each dot represents an individual member’s view on the midpoint of the target range for the federal funds rate at the end of the specific calendar year or over the longer run.
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.
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 September 20, 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 or make recommendations regarding insurance or investment products.
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.