New FOMC Chair – Same Old FOMC?
Given the flattening yield curve, much has been made of late that a potential policy misstep on the part of the Federal Open Market Committee (FOMC) could short-circuit the equity rally over the coming quarters. President Trump’s nominee for the post of FOMC Chair, Jerome Powell, is unlikely to deviate much from current Chair Janet Yellen’s dovish playbook in our view, while continuing to be, above all else, pragmatic and largely data-dependent. The market would be shocked if we didn’t get a 25 basis-point rate hike at the FOMC’s December 12-13 meeting as fed funds futures are pricing in a 98% chance that the midpoint of the FOMC’s target range moves up to 1.375% from the current 1.125%. The current 2018 FOMC dot-plot implies three hikes or more next year with 11 of the Committee’s 16 members projecting the midpoint of the fed funds target to be above 2% by year-end 2018.
The FOMC has undergone and will continue to experience a great amount of turnover within its ranks over the coming months, and given the musical chairs at the FOMC, the dot plot we will receive from the Committee’s December meeting should be taken to mean very little from a signaling perspective. In addition to Chair Janet Yellen leaving her post in early 2018, Vice Chair Stanley Fischer stepped aside in October, and New York Fed President William Dudley announced plans to retire by mid-2018 – this doesn’t even include the four Reserve Bank Presidents serving rotating one-year terms that will become voting members in 2018. Having new officials occupying what are the three most influential roles within the FOMC in 2018 has the potential to be a major source of market volatility and may greatly alter forward rate expectations and the outlook for economic growth/inflation over the course of the coming year.
In our view, inflation will be the biggest potential worry for bond investors over the coming quarters. We expect inflationary pressures to gradually build due to commodity prices rising – specifically in industrial metals and energy-related commodities – as global growth/demand continues on its current trajectory or perhaps even accelerates a bit from here entering 2018. An unanticipated year-over-year jump in average hourly earnings (AHE) growth is what we’re on the lookout for as an increase of over 3% could push bond yields higher on rising inflationary expectations. We have a preference for corporate credit as we enter into 2018 given our positive outlook for the U.S. and global economies, and the recent pullback in high-yield has created some pockets of value where very little existed in late October. Selectivity is key here as late October’s high-yield hiccup highlights how volatile the space can be at times. We continue to advocate for active management across the fixed income landscape.
Source: Bloomberg, Factset
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