Fed’s Inflation Target Misguided? Good vs. Bad Disinflation

For more than a year the Federal Reserve Board has cited inflation below its targeted 2% level as one justification for maintaining its extraordinarily accommodative monetary stance. As of February, the core inflation rate was 1.1%, based on the Personal Consumption Expenditure (PCE)  inflation series, the Fed’s preferred measure of inflation. But there is good reason to question whether the 2% target justifies current policy. Continue reading

Taking Stock in the Economy

Now is a good time to take stock in the current macro environment from a market perspective. Here’s what we think could happen at the end of this year and next year:

Stocks and Bonds

  • It’s been a good year so far for equities. The S&P 500 is up around 24% and the NASDAQ is up 30% year to date through 11/5/13.
  • High yield bonds represented by the BofA ML High Yield Master II, convertibles bonds represented by the BofA ML All U.S. Convertibles Index and preferred stocks represented by the BofA Adjustable Rate Preferred Securities Index have clearly outperformed investment grade bonds represented by the BofA ML Corporate Bond Master Index.
  • High yield bonds are up about 6%. U.S. investment grade bonds, despite the Fed’s wanting to get rates back down, are still looking at roughly minus 1.6% returns .
  • The current economic environment has clearly favored the equity markets and instruments linked to equities. Continue reading

What Should Investors Know about the U.S. Government Shutdown?

Yesterday was the start of a new fiscal year for the U.S. federal government, but failure to agree on a spending plan in time for that deadline left federal coffers short. As a result, a partial government shutdown took effect. It’s important to emphasize that this was a partial government shutdown. Many services remain operational, such as our active military, Medicare/Medicaid, Social Security and airline travel.

What Should Investors Know?
The shutdown may prevent the release of economic statistics in the coming days and this does present an inconvenience. However, the markets yesterday were relatively calm. Equities were flat, to slightly up; bonds were selling off and the dollar seemed to be weaker. But there was no appreciable market movement and it was one of the quietest trading days we’ve had in credit /fixed income for some time. Of course, the longer the shutdown lasts, the more anxious the markets will get.

We expect that this impasse will be resolved one way or another and that the shutdown will be short-term in nature. However, it is not yet clear what the resolutions will be, so it’s difficult to gauge the actual length of the shutdown. That being said, we don’t expect a meaningful disruption in the markets that would cause great concern to investors.

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How Did The Fed Catch Markets Off Guard? What Does it Mean for Investors?

The Fed’s decision on Wednesday caught the markets off guard – rather than begin tapering, as most expected, it held off, announcing it would stay the course. The market seemed thoroughly surprised, which is why the reaction was strong and aligned directionally across most markets – we saw U.S. Treasuries and equity markets rally, while the dollar weakened.

This reaction is ironic because the Fed has gone through a lot of trouble to reduce volatility through forward guidance, press conferences, etc., The Fed’s “body language” since May has suggested that they were going to taper and, had they done so, the markets probably would not have reacted much at all. I thought the Fed was in a good position to start their tapering in U.S. Treasuries because most of the economic data has been improving.

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