The Fed Turns Dovish

Federal Reserve Building

The Federal Open Market Committee (FOMC) today took a dovish turn, indicating uncertainty about the course of the US economy and future interest rate hikes. Chair Janet Yellen indicated a continued bias towards rate hikes in 2016, but made no commitment on the timing. Chair Yellen maintained her stance that Fed policy will be data dependent, but appeared to lack confidence in the Fed’s forecast for the economy. The dovish direction of the FOMC and its uncertain posture on the economy comes on the heels of easing measures by the Bank of Japan (BOJ), the European Central Bank (ECB), and other central banks around the world, opening the door, once again, for investors to pursue risk assets.

The Fed’s forecast on inflation also appears uncertain. In discussing the outlook for inflation, Chair Yellen said the Fed “has not yet concluded that we have seen any significant uptick that will be lasting in, for example, core inflation.” Yet, inflation has been rising. Core PCE inflation, the preferred gauge of the Federal Reserve, rose from the revised 1.46% in December to 1.67% in January, the highest level since February 2013. At 2.3%, core CPI already stands above the FOMC’s 2% inflation target. CPI services inflation, excluding energy, reached 3.1% as of February 29. (See chart below.) Both Core CPI and CPI services inflation have been driven by the upward trends in both housing and medical care.

Economic conditions are generally supportive of the Fed’s new forecast of two rate increases. But based on today’s statement, we no longer believe the Fed will increase rates in April. Of course, if the data remains positive, we still may see a rate hike before the end of the second quarter. However, the June FOMC meeting is scheduled one week before the Brexit vote.

Based on recent economic and market data, we continue to believe US GDP will enjoy 2%-2.5% growth in 2016, driven by consumption, housing and improved government spending. Economic and market data have improved since the Fed’s January meeting:

  • First quarter 2016 GDP growth is estimated at 1.9% by the Atlanta Fed, a significant improvement from the fourth quarter 1% level.
  • Employment continues to make gains, with the higher than expected 242,000 non-farm payroll achieved in the latest February report, and with initial unemployment claims reaching a five-month low and the four-week moving average falling to 267,500.
  • Manufacturing appears to be finally bottoming, as indicated by the latest Industrial Production, where manufacturing did better than the headline data, and ISM Manufacturing reports, which fell to 48.0 in December, but rebounded to 49.5 by the end of February.
  • The global outlook has stabilized, with a bottoming and recovery in oil prices, as well as a bottoming in other commodities. China has taken steps through monetary and fiscal policy to ease the transition of its economy from an investment to consumption driven model, and to affect an orderly and measured depreciation of the Yuan.
  • Financial conditions have eased, as reflected in rallying equity markets and lower corporate spreads. This improvement has been driven by improving US data and the bottoming of commodities prices, as well as by monetary policy easing among global central banks, most notably the ECB, the BOJ, and the Bank of China. In particular, the ECBs actions supporting the banking sector, and the extension of its asset purchase program to include corporate bonds resulted in dramatic spread compression of corporate debt, particularly in the banking sector.

About Ken Taubes

Ken Taubes is Executive Vice President, Chief Investment Officer, U.S. of Pioneer Investments. He is Portfolio Manager of Pioneer Strategic Income Fund, Pioneer Bond Fund and Pioneer Multi-Asset Real Return Fund. Ken joined Pioneer Investments in 1998.
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