Data-Focused Fed Still Dovish, But Brexit Looms

| About: ProShares Inflation (RINF)

Originally published June 16, 2016

By Kristina Hooper, Steve Malin and Greg Meier

The US Federal Reserve's June 15 statement, and Fed Chair Janet Yellen's ensuing press conference, reinforce the fact that the Fed won't move until the economy improves. Investors also learned that the Fed is still keeping an eye on overseas developments, particularly Brexit and negative interest rates, but since the US presidential race doesn't affect economic data, that vote shouldn't influence the Fed.

Data dependency clearly drives Fed decision-making
The Federal Open Market Committee's June decision not to raise rates is further proof just how data-dependent it is. US economic data have been largely weak for months, and the May jobs report seemed to be the final nail in the coffin. While a July hike is still possible, it would only happen if the Fed thinks the May jobs report was an outlier - not the start of a negative trend.

What happens outside the US still matters
In its statement, the FOMC didn't alter its language about "closely monitoring global and financial developments," which means the Fed still has one eye trained overseas. Yellen reinforced this idea in her press conference, specifically telling reporters that negative rates should be a factor in the Fed's decisions. Yellen also confirmed that the UK's "Brexit" vote did, in fact, factor into the FOMC's latest thinking, explaining that it "could have consequences for economic and financial conditions in global financial markets."

The US presidential election shouldn't affect rate hikes
At the same time, there's a difference between the UK's referendum on EU membership and the US presidential election - at least for the Fed. When asked about the presidential race, Yellen said it would not have an impact on the path of rate hikes because the Fed is looking at economic data.

The Fed is managing down its policy prescription
In a continuation of a trend we saw in March, the Fed has downwardly revised its view on the appropriate path of rate hikes:

  • The Fed's median policy prescription for 2016 still calls for two rate hikes - although it is noteworthy that six FOMC members now favor just one rate hike, up from just one FOMC member in March.
  • The FOMC has gotten more "dovish" with its dot plot over the longer term. The Fed cut its policy prescription for the path of interest rates for 2017 and 2018; this is a substantial departure from December's policy prescription.

Views from our investors
We asked some of our US-based portfolio managers for their thoughts about the latest Fed news. Here's what they told us.

  • Jeff Parker, CFA, Co-CIO Equity US: "The Fed wants to raise rates because they know they're behind the curve. Unfortunately, traditional economic data are not supportive. The Fed is on hold until the data get better."
  • Doug Forsyth, CFA, CIO US Income & Growth Strategies: "It's likely the Fed will stay steady until after the election, and most likely all year. This is a cautious and conservative Fed that avoids doing anything that could accelerate volatility. With Brexit and the unusual presidential race on the horizon, the Fed would likely move only if forced to."

Expect volatility and search wider for income
While market participants don't expect rates to rise for months, it seems clear that every Fed meeting holds at least the possibility of a hike - but, of course, the outcome will be dictated by the data.

It is worth noting that, according to the Chicago Mercantile Exchange, the first time the market expects more than a 40% chance of a rate hike is February 2017. In this environment, investors should be prepared for more uncertainty and volatility, and with rates staying "lower for longer," investors should keep looking to less-traditional sources for their income needs.