As Expected, but Not as Hoped
December 21, 2018
The portfolio managers of Pacific Funds Fixed-Income Funds share their perspectives on the most recent Federal Open Market Committee meeting.
Informational commentary from Pacific Asset Management, manager of Pacific Funds Fixed-Income Funds.
On December 19th, the Federal Reserve (Fed) raised the target fed funds rate by 25 basis points (one basis point is equal to 0.01%) to a target range of 2.25–2.50%. This is the fourth hike of 2018 and the ninth of the current cycle. There were minor language changes relative to the November statement, most notable was the addition of verbiage pertaining to "monitoring global economic and financial developments." In addition to the rate hike, the Federal Open Market Committee (FOMC) also released economic projections and “dot plots.” Our brief thoughts and language changes are noted below.
There were very few language changes relative to the September statement. There was, however, change in the verbiage pertaining to household spending and business investment. Language changes and our brief thoughts are noted below.
- The FOMC raised the range for the federal funds target rate to between 2.25% and 2.50%.
- There were minor verbiage changes regarding unemployment and further rate increases.
- The Fed replaced “declined” with “remained low” as it relates to unemployment and “expects” with “judges” in regard to further rate increases.
- The sentence, “Risks to the economic outlook appear roughly balanced” was removed and replaced with “The Committee judges that risks to the economic outlook are roughly balanced, but will continue to monitor global economic and financial developments and assess their implications for the economic outlook.”
- New forecasts showed the Fed changed its stance regarding rate increases in 2019, moving from three to two potential hikes in the coming year.
- Expectations are for two more hikes in 2019 and one in 2020.
- Median expectations now suggest an end-of-year target rate of 2.375% for 2018 (current), 2.875% for 2019 (two hikes), 3.125% in 2020 (one hike), and 2.750% for the longer run. Note that current forecasts have the target rate above the longer-run rate in 2019 and 2020.
- Economic projections were generally revised lower, with real gross domestic product (GDP) revised modestly lower by 0.1% to 3.0% in 2018, by 0.2% to 2.3% in 2019, and unchanged at 2.0% in 2020. However, the longer-run projection was revised higher, up 0.1% to 1.9%.
- The core personal consumption expenditures (PCE) price index for inflation was lowered for both 2018 and 2019 by 0.2% to 1.9% and 2.3%, respectively.
- The Fed also made a widely expected technical adjustment, raising the rate it pays on banks’ excess reserves by just 20 basis points to keep it within the targeted range.
While there were certainly reasons to raise the target rate, given the significant rise in market volatility, lack of inflation pressure, global trade headwinds, the forecast for slowing global growth, and housing weakness, the risk/return for a pause seemed to many like the prudent decision. In the event of a raise (a majority of forecasts thought the Fed would raise, not necessarily that it should raise), markets were hoping for a very dovish tone in future hikes and perhaps some discussion about the reduction of the balance sheet. Even though the number of hikes in 2019 were dropped from three to two, the Fed also indicated its current expectation is to run above the long-term neutral in 2019 and 2020. This forecast is in the face of a lower adjustment to GDP and PCE in these years. The tone regarding any slowdown of balance-sheet reduction was very status quo.
In addition to the rate hike and projections, comments from Federal Reserve Chairman Jerome Powell further eroded market confidence that the Fed would not choke the current economic expansion. Regarding the recent volatility and “softening” in the economy, Powell stated, “In our view, these developments have not fundamentally altered our outlook. Most FOMC participants have, instead, modestly lowered their growth and inflation forecasts for next year.” He also mentioned, “Policy does not need to be accommodative,” as the U.S. economy continues to move forward and appears to no longer need the Fed’s support either through lower-than-normal interest rates or by maintaining the current levels of the balance sheet. Regarding the FOMC’s revision to its forecast for the fed funds rate, Powell commented, “The projections also show a modestly lower path for the federal funds rate, which should support the economy and keep us near our goals.” Powell also continued to reiterate the FOMC’s data dependence and that its decisions are not driven by any particular market, event, or political opinion.
While this rate hike and forward projections were dovish in intent, the Fed’s decision and dot-plot revisions were a missed opportunity to be accretive to price stability, and thus, a potential misstep. Risk assets declined sharply after the announcement and continued to weaken as projections were released and the press conference held. Of note, this was only the third rate increase of 77 since 1980 that was made when the S&P 500® index was down over the last three, six, and 12 months prior. As markets attempt to discount the impact of tariffs, Brexit, a looming government shutdown, and weakening economic growth, many hoped the Fed would help this discounting process. Instead, the central bank added to it.
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.
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.
The S&P 500® index is a market capitalization-weighted index of 500 widely held stocks often used as a proxy for the U.S. stock market.
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 December 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.
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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, is the investment adviser to Pacific Funds. PLFA also does business under the name Pacific Asset Management and manages certain funds under that name.