The Fed Stays Upbeat as Global Clouds Gather

By Brian Dolan, Head Market Strategist Fed—Steady as She Goes

On Wednesday, the FOMC held rates steady as expected and essentially maintained a status quo policy outlook. Current market consensus continues to hold that the Fed may begin to raise rates at its June 17 or July 29 meeting, though there have been some subtle shifts toward a later date. The Fed statement included an upgraded assessment of the US recovery (from ‘moderate’ to ‘solid’), while also noting that job gains have improved, using the term ‘strong’ instead of the prior ‘solid’ to describe employment conditions.

The Fed also noted that inflation rates are likely to remain under pressure in the near term, but that it still expected inflation rates to rise gradually to near its 2% target rate over the medium term. The Fed appears to be downplaying the risks of too low inflation, attributing it to recent declines in energy prices and the strength of the US dollar.

Global Headwinds

Perhaps most ominously, the Fed noted it would consider “international developments” in its future policy decisions, alluding to growing concerns a recession is looming in Europe, while Japan is in recession, and China continues to post relatively sluggish growth.

We expect that Europe will experience further softness in the months (and likely years) ahead, and we think the risks to the global outlook from such a result will lead the Fed to stay lower for longer. We also look for US growth to moderate significantly from the 3Q’s unsustainable 5% annualized rate. Friday will see the preliminary estimate of US 4Q GDP, with the market consensus coming in at a 3% annual rate.

Markets were not comforted by the Fed’s concerns over the global headwinds and stocks declined following the FOMC statement, despite its mostly upbeat tone. Disappointing corporate earnings also contributed to a sense of concern and led to further profit-taking selling.

Potential Correction Opportunities

Stepping back for a moment, we’re still left with the view that we remain in a relatively stable, and ultimately zero-rate investment environment. This leaves investors with no serious alternatives to continuing to buy into stock market dips. Also, as markets continue to reassess the outlook for the Fed’s rate path, we would look for expectations to be postponed still further. We think this may lead the US dollar to surrender some of it recent gains, though it may only be a case of it not strengthening further.

We think the current correction in equities may offer opportunities to add to long positioning, but from more advantageous levels. We would focus on S&P 500 levels of 1950 (base of the daily Ichimoku cloud) and 1920 (top of the weekly cloud) to selectively add to longs.