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2 months ago

Is the Fed Missing Something?

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On Tuesday, Federal Reserve (Fed) Chair Janet Yellen addressed the National Association for Business Economics to discuss “Inflation, Uncertainty, and Monetary Policy.” The topic was certainly timely as the Fed has been dealing with below-target inflation for some time now.

The Fed’s messaging continues to indicate that it believes inflation will hit its 2% target in the medium-term; however, Yellen’s speech did broach the possibility that the Fed may be wrong, and that things like a misjudgment of labor market strength, a misunderstanding of the impact of inflation expectations, or a missing piece of the fundamental inflation picture could lead to under- or over-shooting the 2% target over time.

The discussion was balanced overall, and Yellen did not actually indicate that the Fed was missing something, just that the possibility exists. For that reason she reiterated that it’s important the Fed remain data-dependent with respect to the future path of rate hikes. However, when Yellen talked about the policy implications of this uncertainty, she indicated that waiting for inflation to reach 2% before raising rates could leave the Fed behind the curve. Therefore, she argued that it makes more sense to continue to gradually raise rates with the option to pause the process based on incoming data.

The main takeaway for investors is similar to that of the Fed’s September meeting statement: Even though inflation hasn’t reached 2%, and the Fed has embarked on balance sheet normalization, a December rate hike remains a strong possibility barring unforeseen developments.

As recently as a month ago fed fund futures markets were pricing in just a 38% chance of a rate hike in December. Following the Fed’s September meeting and Yellen’s speech, expectations are now near 76% (down slightly from a high of 81% after the speech). However, even though markets and the Fed are starting to agree on December, market expectations for the future path of rate hikes continue to be much lower than the Fed’s, a concept we talk more about in this week’s Weekly Economic Commentary, “Fed Versus the Market – Round 2.”

IMPORTANT DISCLOSURES

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The opinions voiced in this material are for general information only and are not intended to provide or be construed as providing specific investment advice or recommendations for any individual security.

The economic forecasts set forth in the presentation may not develop as predicted.

This research material has been prepared by LPL Financial LLC.

To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that LPL Financial LLC is not an affiliate of and makes no representation with respect to such entity.

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3 months ago
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