Last Wednesday’s statement by the Federal Reserve did not include any changes to monetary policy. In fact, there was little in the Fed’s statement that surprised investors. The Fed maintained its language that it “can be patient in beginning to normalize the stance of monetary policy.”
There is still much speculation about exactly when the Fed will begin raising rates. Most market participants take the word “patient” to mean that the Fed will not raise rates for at least two meetings from last week’s. That means we should not expect a rate increase before June at the earliest.
To be honest, the Fed’s use of the word “patience” can be interpreted as code for “We don’t know.” The reality is the Fed has not yet determined when it will start raising rates, nor the pace at which it will raise them once it starts.
There were a few changes in the Fed’s most recent statement as it upgraded its assessment of both economic growth and the labor market. At the same time, it acknowledged lower inflation (due to falling energy prices) and lower market-based measures of inflation expectations. Over the long haul, however, the Fed’s forecast is that the eventual end of energy price declines as well as the stronger labor market will lift inflation back up toward its target of 2%.
Clearly, the labor market is strengthening as evidenced by the decline in the unemployment rate in December to 5.6%, which represents a six-year low. The economy also added 252,000 workers last month. For 2014, the economy added almost 3 million jobs, representing its biggest annual gain since 1999.
While the Fed appears to remain confident in its outlook for higher inflation and lower unemployment, it still seems likely that it will raise rates this year for the first time since 2006. One potential thorn in its plan is weakness in international economies such as Europe. In fact, Fed officials acknowledged they will take “international developments” into account when considering an increase.
At the same time, central bank policy in major economies like Europe and Japan remain at zero or lower. There is also little inflation. In the U.S., the growth rate remains positive even as the Fed maintains its accommodative stance. The truth is that there is little reason for them to change anything.
Our best guess remains that the first rate increase will occur by year end, but it could be delayed until 2016. Either way, we do not expect the Fed to be aggressive in raising rates. As indicated by the Fed’s language, it does not know for certain when it will start raising rates. Neither do we.
Against this backdrop, we continue to maintain our positive long-term view of equity markets and will remain diligent in our efforts to identify well-managed companies trading at attractive valuations for client portfolios.