Tug-of-War: Fed Signals vs. Market Pricing

by: , Managing Director, Economist, and Portfolio Manager, New York Life Investment Management

As expected, the Fed raised the Fed Funds Rate by 25 bps at its June meeting. Committee projections suggest one more rate hike this year and a pace of roughly three hikes per year in 2018-19. The announcement was seen as “hawkish”, as the Fed also suggested a gradual balance sheet normalization program to begin sometime this year.

Markets price in a little more than one 0.25% hike per year in the near future, and a tug-of-war between the Fed’s signals and market pricing could be a source of volatility going forward.

However, the Fed is facing a conundrum at the moment with a tightening labor market, yet inflation data has recently been surprisingly low. In May, core inflation dropped to 1.7% from 1.9% in April – a two-year low.

Core Inflation (Excluding Food and Energy)

Sources: Thomson Reuters Datastream, New York Life Investments, May 2017. Past performance is no guarantee of future results. An investment cannot be made directly into an index.

Large price cuts for unlimited cell phone data plans have recently pushed down inflation. That’s an example of how technological changes and automation are causing structural downward pressure on costs. The good news is that these structural changes also enable the economy to operate at a higher activity level, without stoking inflationary pressures.

Despite recent weakness, it is too early to rule inflation completely out. With increasing signs of labor market tightness, a stabilizing U.S. dollar, and a pickup in global economic growth, core inflation is more likely to trend up than down over the next 6-12 months. On the growth front, consumer spending showed a solid trend for the March-May period, and indicators for manufacturing in June looked encouraging.

Overall, growth signals for the second quarter point to a decent rebound from a weak first quarter.

Indicators Point to Q2 Rebound

Sources: Thomson Reuters Datastream, New York Life Investments, May 2017. Past performance is no guarantee of future results.

Clearly, weakness in inflation does not necessarily equate to weakness in growth, and data actually point to tailwinds for corporate revenues in Q2. For investors who worry about the potential for an uptrend in inflation, commodity-sensitive assets can be a good way of diversifying a portfolio.

The information contained herein is general in nature and is provided solely for educational and informational purposes. New York Life does not provide legal, accounting or tax advice. You should obtain advice specific to your circumstances from your own legal, accounting and tax advisors.

All investments are subject to market risk, including possible loss of principal. There is no assurance that the investment objectives mentioned will be met. Diversification cannot assure a profit or protect against loss in a declining market.

The information and opinions contained herein are for general information use only. MainStay Investments does not guarantee their accuracy or completeness, nor does MainStay Investments assume any liability for any loss that may result from the reliance by any person upon any such information or opinions. Such information and opinions are subject to change without notice, and are not intended as an offer or solicitation with respect to the purchase or sales of any security or as personalized investment advice. There can be no guarantee that any projection, forecast, or opinion in these materials will be realized. Past performance is no guarantee of future results.

The core CPI index excludes goods with high price volatility, such as food and energy. This measure of core inflation systematically excludes food and energy prices because, historically, they have been highly volatile and non-systemic.

MainStay Investments® is a registered service mark and name under which New York Life Investment Management LLC does business. MainStay Investments, an indirect subsidiary of New York Life Insurance Company, New York, NY 10010, provides investment advisory products and services. Securities distributed by NYLIFE Distributors LLC, 30 Hudson Street, Jersey City, NJ 07302, a wholly owned subsidiary of New York Life Insurance Company. NYLIFE Distributors LLC is a Member FINRA/SIPC.


Poul Kristensen, CFA

Managing Director, Economist, and Portfolio Manager, New York Life Investment Management

Poul Kristensen, CFA is Managing Director, Economist, and Portfolio Manager with New York Life Investment Management’s Strategic Asset Allocation & Solutions (SAS) Group

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