International events often influence global capital markets. In recent weeks, we have witnessed horrific loss of life in multiple terrorist attacks. Turkey shot down a Russian fighter plane flying over its air space. All of these happenings are unsettling. Yet, on balance, the stock and bond markets of the developed world have shown surprising resilience. It is too early to tell what the economic consequences will be of any one of these occurrences. Will travel be curtailed? Will people have the confidence to shop? Will international trade be affected?
For now, focus has returned to central bank activity. The Federal Reserve Bank (Fed) and the European Central Bank (ECB) seem to be on divergent paths, with the Fed possibly raising rates in December and the ECB accelerating bond purchases. A challenge for all of us has been second guessing the Fed. With its policy of transparency, it has telegraphed its desire to increase short-term interest rates. Yet, to date it has done nothing. Our view is that global growth is slowing and that the data does not support a rate increase now. However, after so much talk, the credibility of the Fed is on the line; so, a rate increase in December may well occur.
Then what? Fed policy makers have been anticipating wage increases and 2% inflation. Since the models they have been using have not worked, there seems to be an internal and public debate about whether the economy is on a path to resume historic growth rates or, perhaps, we are now in a prolonged slow growth environment, characterized by modest wage increases and tepid inflation. The Fed has traditionally looked at the Phillips curve, a theory based on a trade-off between unemployment and inflation. With official unemployment on the low side, inflation has failed to materialize. And in a global market place, how much latitude does the Fed have to move in a different direction from the ECB, the Bank of Japan and the Bank of China? Higher interest rates in the United States than in other developed economies would attract investors and drive up the dollar, potentially prejudicing the earning power of large multinationals.
We are sympathetic with the Fed’s desire to move off of zero interest rates, an emergency measure enacted seven years ago. However, the economic recovery that the Fed has been forecasting has yet to materialize. Policy makers have uniformly said they will raise rates slowly, whatever that means. Goals and timing vary considerably among Fed members. Unless, the data improve, the Fed has little room to maneuver. Perhaps, we are expecting too much from them. Despite distortions to asset markets, there is little evidence that the extraordinary experiment of serial quantitative easing has spurred economic growth.
Ultimately, economic growth and corporate earnings will determine interest rates and stock market performance. In the meantime, though, the Fed continues to dominate the news, at least for market watchers. Hopefully, the Fed will not be a source of further uncertainty. We have enough challenges, geopolitical and economic, without constantly wondering what the Fed will do.
- The views expressed are provided for information only and are not to be used or considered as an offer or solicitation to buy or sell securities or investment products. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you consult your financial advisor.
- Data provided LPL Financial and Michael Shaoul.
- All indices are unmanaged and may not be invested into directly.
- The economic forecast set forth in this presentation may not develop as predicted, and there can be no guarantee that strategies promoted will be successful.
- Stock investing involves risk including loss of principal.