Wednesday, 17 June 2015

FOMC thoughts - low(er) growth and a lower dollar

Ah, Federal Reserve policy and press conference day.  Always an excitable moment but - as is often the case - the more excited you are about something the less exciting the reality is.  Today's FOMC statement (link here) had that feel to it.  The key comment to me in the formal text was this one: 

'The Committee anticipates that it will be appropriate to raise the target range for the federal funds rate when it has seen further improvement in the labor market and is reasonably confident that inflation will move back to its 2 percent objective over the medium term'

Ah...the old 'reasonably confident' line.  Janet Yellen expanded on this in the press conference with a clear adherence to a data dependent decision-making methodology.  I am sure it was always this way but in this world of analysis and emphasis placed on even the merest hint about something maybe it had to be plainly reiterated in (ahem) Janet and John style.  

Two aspects particularly struck me.  First 'the dots' which usefully in this Financial Times graphic shows the median position of interest rates over time.  A near 3% interest rate level by the end of 2017?  That feels unlikely to me.  

My instinct would remain that the surprise may be the more elongated low/no interest rate rise period.  Consensus would have it that a rate rise is relatively imminent (see below for some betting industry extrapolated proportions) but all this can hardly be described as anything approaching a normal cycle, can it?

Odds of Fed rate hikes by meeting date:
Jul 2015 0%
Sep 22%
Oct 43%
Dec 62%
Jan 2016 76%
Mar 85%
Apr 92%
Jun 96%

The lack of normalcy is best captured by the Fed's own forward forecast even ignoring the downward revision in 2015 real GDP hopes (1.8-2%) compared to the March projection of 2.3-2.7%.  For me the longer run metric of 2-2.3% is simply not that exciting...but yet market valuations are high helped by that wonderful distorter of DCF models in the form of ultra low interest rates.  

So how about the market impact.  No surprise that the US bourses closed up - as shown below this is very much the norm.

No, the most striking aspect was the weakness of the US dollar.  Good news for corporate America and the (as noted regularly on this page) shabby shorter-term earnings growth profile of the S&P 500.  Less good news for Europe of course and unsurprisingly a higher euro (the heady heights of 1.13+ against the dollar even with the Greek crisis brewing) pushed the DAX future into negative territory.  So a bit of volatility (like Draghi the other week Yellen made no apology for enhanced volatility) but ultimately no radical regime shift.  

From here I don't expect big FX shifts (euro is 8-10% below a fair PPP value but that's reasonable given the Greek issues and general limited structural reform) and hence US earnings are still unlikely to romp on the back of FX weakness.  No, the key future insight is centred on the lack of sharp GDP improvement and how this blends into equity valuations over time.  It may look good on the DCF BUT the reality is going to get more specific. 

We got lower growth and a lower dollar but all the FOMC chat says to me is that we are moving deeper into the midst of a stock picking market.  On your investments you have got to get active.  

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