Interest rates are staying low for a very long time.
On Thursday at the conclusion of its Federal Open Market Committee (FOMC) meeting, the Fed announced it was keeping its benchmark interest rate target at near 0 to 0.25%, which is where it’s been since December 2008.
“Recent global economic and financial developments may restrain economic activity somewhat and are likely to put further downward pressure on inflation in the near term,” the Fed said in its statement. “The Committee continues to see the risks to the outlook for economic activity and the labour market as nearly balanced but is monitoring developments abroad. “
“There were two key messages in the Fed’s directive,” Bank of America Merrill Lynch’s Ethan Harris said. “First, they are very concerned about global economic and financial developments … The other new message was some concession on inflation expectations: the old directive said that ‘market-based measures of inflation compensation remain low’, while the new directive said they ‘moved lower.'”
So, the Fed sees problems.
Here’s your Monday Scouting Report:
Low inflation is a very big deal. There was little consensus about what the most important message was. Some thought it was the talk about inflation. “The lack of progress on inflation was the main reason that we expected the FOMC to hold off on raising the federal funds rate at this meeting,” HSBC’s Kevin Logan said.
“Inflation outlook remains the fundamental question,” UBS’s Drew Matus said. “The Fed’s outlook for unemployment and growth both suggest a tightening is near. The wild card remains inflation. However, we expect soft inflation will have more of an influence on the pace of tightening than on the start of tightening.”
Global developments are a very big deal. No one would downplay the Fed’s increasing emphasis on international concerns. “The global economy is in the driver’s seat,” Morgan Stanley’s Ellen Zentner said. “The FOMC statement was decidedly dovish and suggests that policy decisions now hinge completely on how developments abroad evolve.”
Here’s Wells Fargo’s John Silvia: “Global developments were brought into the discussion. These developments bring in another element of uncertainty. We believe that a resolution of the global picture is unlikely to provide much guidance in the short run. While it may be said that a great majority of the FOMC expect a rate increase by the end of this year, this appears inconsistent with any reasonable expectation of a resolution of the global picture. Perhaps the global issue is just a temporary reason for no action. If so, this simply adds to uncertainty given that the global situation has made a sudden appearance and that these developments are difficult to quantify and unlikely to change much before the end of the year — yet a great majority expect to raise the funds rate by the end of the year? Uncertainty persists.”
Realistically, the Fed could wait until 2016. Like Silvia said above, the uncertainty from overseas is unlikely to dissipate any time soon. Generally speaking, there were many economists who felt there wasn’t enough time between now and the October and December FOMC meetings for enough data to come out that it would materially change the Fed’s current mindset. Barclays’ Michael Gapen was quick to reiterate his call that March 2016 was the most likely date for the first rate hike. “The explicit reference to economic developments, which may take longer to resolve, plus the heightened focus on inflation, in our view, lowers the probability of a near-term hike. Weak growth prospects in EM Asia are unlikely to fade this year and, indeed, are quite likely to remain in focus next year. We have trouble seeing a rate hike before year-end and maintain our call for a March 2016 lift-off. “
RBS’s Michelle Girard’s new baseline call is for the Fed to wait until March: “We have long highlighted the fact that if the Fed did not hike in September, we would assign highest odds for the first Fed move coming in March (the first meeting with a press conference in 2016). That is officially our new call. … As we have noted, we do believe strongly that the FOMC wants to hike this year to deliver on the guidance they have long provided (a view reinforced by the fact that 13 of 16 participants in today’s SEP still say hiking rates for the first time in 2015 will be appropriate). That said, we think the Fed has likely missed their window. By their own admission, policymakers’ confidence in inflation moving towards the 2% mandate has been undermined, even though the unemployment rate has fallen further. We simply do not think the FOMC’s confidence in inflation moving higher (and therefore the case for tightening) will be that much stronger in one to three months.”
- Existing Home Sales (Mon): Economists estimate the pace of sales fell 1.6% in August to an annualized rate of 5.5 million units. From Bank of America Merrill Lynch: “Mortgage purchase applications have slipped lower over the prior two months while pending home sales have softened. Moreover, the data are due for a reversal after the strong performance over the prior several months.”
- Richmond Fed Manufacturing (Tues): Economists estimate this regional manufacturing index climbed to 2 in September from 0 in August. From UBS’s Sam Coffin: “The Empire State manufacturing survey remained very weak in September. Other factory measures had not deteriorated to the same extent as the Empire State measure in earlier months.”
- Markit US Manufacturing PMI (Wed): Economists estimate this manufacturing index climbed to 52.8 in September from 53.0 in August. Any reading above 50 signals growth.
- Durable Good Orders (Thurs): Economists estimate orders fell 2.3% in August. Nondefense capital goods orders excluding aircraft — or core capex — are estimated to have slipped by 0.2%. From Morgan Stanley’s Ted Wieseman: “Rising global and market uncertainty appear to be keeping business investment cautious…Our MSBCI survey has seen a substantial slowdown in the capex plans index in the past two months, and regional Fed manufacturing surveys have also showed sluggish capex plans. For headline orders, industry data pointed to upside in aircraft, but defence will probably reverse a sharp gain in July within a flat to declining long-run trend.”
- Initial Jobless Claims (Thurs): Economists estimate initial claims climbed to 275,000 from 264,000 a week ago. From Nomura: “The recent claims data suggest that involuntary layoffs remain low and job creation remains robust. We expect initial jobless claims to remain at low levels for the week ending 19 September.”
- New Home Sales (Thurs): Economists estimate the pace of sales climbed 1.6% in August to an annualized rate of 515,000. From Bank of America Merrill Lynch: “The NAHB homebuilder survey continues to improve, highlighting greater demand for new construction properties. That said, we don’t expect a sharp turn higher given that mortgage purchase applications have weakened recently. We also see a risk of months supply ticking up as the gain in housing starts translates to inventory.”
- Kansas City Fed Manufacturing Activity (Thurs): Economists estimate this regional manufacturing activity index improved to -6 in September from -9 in August.
- Q2 GDP (Fri): Economists the new estimate for Q2 GDP will show growth was unchanged at 3.7%. Here’s Credit Suisse: “The composition may tilt more favourably towards domestic final sales. Upward revisions to consumer services spending (from the Census quarterly service data) are expected to offset a wider trade deficit (driven mainly by higher imports). ”
- Markit US Services PMI (Fri): Economists estimate this services index fell to 55.6 in September from 56.1 in August.
- U. of Michigan Sentiment (Fri): Economists estimate this index of sentiment will be revised to 86.5 in September from 85.7 earlier this month. From Barclays: “We forecast the University of Michigan consumer sentiment index to be revised up to 87.0 in the final September estimate, from 85.7 in the initial estimate. We attribute the sharp decline in the initial estimate to the rise in financial volatility and increasing concern over international economic developments. Financial markets have eased a bit since the preliminary survey period however, and jobless claims and retail gasoline prices have continued to decline.”
We now know that low inflation and global volatility has the Fed thinking low interest rates for a very long time.
So, what are Wall Street’s stock market strategists saying?
Deutsche Bank’s David Bianco: “We trim our 2015 end S&P target to 2100 from 2150 on continued uncertainty. The Fed’s delay might reduce the threat to S&P EPS from weak oil prices and a strong dollar, but it makes the outlook for long-term Treasury yields and thus the appropriate S&P PE more uncertain. There are good reasons why interest rates should stay low through this cycle, but we would be more confident that the 10yr yield doesn’t exceed 3% and that the Fed Funds rate doesn’t exceed 1% in 2016 or 2% in 2017 had the Fed made a small hike yesterday. In our view, the key to an 18 trailing PE in a slow and ageing expansion is low longterm real interest rates. This is less likely if the Fed falls behind the curve.”
UBS’s Julian Emanuel: “The S&P 500 in our view remains in the process of forging a medium term bottom off the late August lows, fortified by the solid US economic backdrop, reasonable valuations, and a level of fear as measured by the richness of downside put options to bullish upside call options (“steep skew”) above the levels observed during the depths of the Financial Crisis in 2008-09. In a higher volatility environment, where interest rates will rise — eventually — cash is likely to command a premium. We continue to prefer cash rich companies in Health Care, Technology and Financials sectors.”
Goldman Sachs’ David Kostin: “With fed funds on hold near zero, lower “quality” stocks may see a tactical bounce but we expect higher “quality” stocks and firms with strong balance sheets will outperform once rate hikes begin. The Fed’s no hike decision prompted a sharp drop in 2-year Treasury yields and a weaker US dollar which eased financial conditions … [S]trong balance sheet and higher quality stocks consistently outperform once the rate hiking cycle begins, as investors reward the firms best equipped to weather tightening financial conditions.”
JPMorgan’s Jan Loeys: “A dovish Fed should be in principle good for equities. But not a Fed that turns dovish because it sees higher downside risks to growth and inflation globally. As a result this week’s FOMC meeting appears to have dented rather than boosted equity investors’ confidence … A dovish Fed is unequivocally bad for banks. We had exited our bank overweight a few weeks ago … Utilities, a rather under owned defensive sector, and small caps, continued to outperform this week in the US. We like both sectors as attractive defensive plays in the current environment of high uncertainty, high cyclical weakness, low interest rates and reduced trading liquidity.”
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