When the Fed held off hiking rates in June, equity markets surged. However, the credibility of the Fed eroded, due to their verbal chatter signaling a desire for higher rates leading up to their meeting, only to be followed by no action.
Here's the case for why I think the Fed is dovish and not hawkish and why, according to their own estimates and indicators, the Fed has little reason to rush to hike rates.
Why the Fed is Slow to Hike:
GDP growth has been unimpressive.
Recently, the Commerce Department reported that U.S. Gross Domestic Product grew at a 1.2 percent annual rate compared to .8% the first quarter. But this was well short of the forecasts of 2.5% growth. As you can see from the chart above from the U.S. Bureau of Economic Analysis, the trend of slower growth has been in tact since Q4 2014. A 1.2% annual rate is well below the Fed's forecast.
(click to enlarge)
Compared to the Fed median forecasts of 2% growth; from their Monetary Policy Report issued in June; Janet Yellen and other Fed members are not forecasting stellar growth for the world's largest economy. In fact, their 2% target goes out beyond 2018.
Real gross domestic product (GDP) is estimated to have increased at a sluggish rate in the first quarter.
- Janet Yellen statement from the Monetary Policy Report (MPR) sent to Congress in June
Inflation Outlook is Low.
Despite persistently weak productivity growth, measures of labor compensation show some tentative signs of acceleration. Overall consumer price inflation has continued to be held down by lower prices for energy and imports.
- Janet Yellen and the Fed's MPR to Congress on June 21, 2016
PCE Inflation has long been one of the Fed's favorite measures of inflation. Looking at their forecasts from the table, the Fed expects 1.4% in 2016 and to remain below their 2% target (where they would consider hiking rates) in 2017. In fairness, the Fed will not wait until inflation approaches the 2% target before hiking.
Business Investment Is Slowing.
With slowing business investment, further downward revisions to GDP growth are likely. And for Yellen to call this a "concern" means it's a big deal.
An area of concern, however, is the softening in business fixed investment in recent quarters, even beyond those sectors most directly affected by the plunge in energy prices.
- Janet Yellen
Business investment is a leading indicator for economic growth and with investment slowing, future GDP growth is likely to remain lackluster.
Uncertainty - Brexit
As we all well know, the potential Brexit fallout effect on the global economy has held central banks hostage and until there's clarity, expect little action.
Heightened global financial market volatility early this year damped confidence both domestically and abroad, but financial conditions have generally eased somewhat in recent months.
- Janet Yellen
If the Fed does not hike this year, this would normally be bullish for equities like the SPDR S&P 500 Trust ETF (NYSEARCA:SPY). The S&P spiked following the Fed's lack of action in June and had little to do with corporate earnings.
These gains from the post-Fed-meeting bounce are likely to be tentative until the market can get more clarity from the Fed during their September 2-day meeting beginning on the 20th.
Equities may be vulnerable either way. If the Fed doesn't hike because of an economic slowdown or global uncertainty, equities may be vulnerable to a correction. And if the Fed does hike and signals more hikes in the coming months, equities are at risk as well.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.