Much has changed since the Portfolio Review of August and much has stayed on track. Our expectation that the Federal Reserve, America’s central banker, would remain at the zero rate level was confirmed yesterday in a much anticipated Committee meeting. If television viewer ratings were measured for the “announcement” I am sure they would have ranked in the Top 10. OK, maybe at least amongst the investment community. Rates are unchanged.
What has changed is most of the world’s GDP forecasts. If you are a reader of our earlier commentary you will find it no surprise that we have been saying for quite some time that both domestic and global GDP expectations were built on hope rather than solid economic facts. This usually happens during a recovery. Everyone expects a rapid recovery quickly returning to Happy Days. Unfortunately, the world of investments follows more practical slower than expected paths. In our view the recovery has been a very nice, slow and steady, while moving to the upside, regaining value along good measures of increased economic activity.
Domestically, housing has exceeded or is approaching many of the pre-2008/2009 values and not demonstrating signs of exhaustion. Retail activity has improved over previous levels while industrial production has returned to a good level supporting industry sectors dependent upon capital expenditures. Employment has improved on all fronts including unemployment rates and recently improved productivity. Personal income has improved as more people are working and all of the new entrants to the workforce have been absorbed while not creating an inflationary environment. Internationally, EuroZone countries are much better than just 24 months ago and Asia/Pacific markets, including Japan are moving forward. China has slowed on a percentage growth rate level but in terms of absolute dollars it is much larger than in previous years and therefore a strong contributor to overall global growth. As in previous recoveries, much of the recovery occurs well in advance of the “experts” recognition. There are always factors that are not performing to expectations. This creates a view or maybe justification as to why the recovery is not perfect. Just as I am sure there are some technology experts that will not abandon the DOS operating system because Windows still has “bugs”.
Why did the Federal Reserve not increase interest rates yesterday? We think the answer in straight forward; the data did not support the increase. Even though employment is improving it is not strong enough to bring about wage inflation nor inflation reflected in products and services. We are at “full” employment at 5.1%, some believe that occurs at 3.0% but I believe most would agree that at the 5.0% range, employment factors are good. The other parameter within the Federal Reserve’s mandate is inflation. Outside of healthcare and food, inflation has been well behaved and is most likely will remain flat for some time. Scarcity of raw materials nor labor has surfaced and until either one begins to occur, prices will remain controlled.
Also, I believe there was consideration given to the fact nearly every central banker around the world is following some level of monetary easing, even Russia. The U.S. economy is doing well, but would it be strong enough to take an increase in rates and currency such that it would not give international manufacturers an advantage? Probably not. A rate increase certainly would raise the associated costs of all financing during a period where debt incurrence is not robust thereby potentially slowing economic activity. Additionally, the U.S.$ would most likely strengthen further placing American producers at a pricing disadvantage again potentially slowing the economy. The downside probability was simply greater than the upside gain of regaining use of interest rates as a central banker tool. The Fed wants this tool back in the toolbox. I think it will just have to wait until other nations begin to see stronger economic activity and move away from quantitate easing (QE) and move to a neutral position as the American Federal Reserve many months ago.
Now the conversation starts about a rate increase for October or December. It will be difficult to raise rates until global GDP strengthens a bit more and global inflationary pressures begin to appear. In a highly competitive world where barriers associated with trade and commerce are constantly being reduced, monetary policy is not a domestic only event. It may take until 2016 before rates begin to increase around the world.