By: Mark Simenstad, Vice President and Head of Fixed Income Funds March 17, 2016
The Federal Reserve’s recent decision to keep interest rates at the current level should be good news for American manufacturers, who have seen their competitive advantage diminish in the global market as the value of the dollar has escalated in recent years.
After the European Central Bank announced recently1 that it would begin buying up corporate bonds to bolster the credit market, rates in Europe have moved deeper into negative yield territory. If the Fed had raised rates, the dollar would probably have moved up strongly, dealing another blow to U.S. manufacturers. The rising dollar has already increased the cost of U.S. goods abroad, making U.S. manufacturers less competitive.
With the Institute for Supply Management (ISM) index2 still slightly below 50, the manufacturing sector is already showing signs of weakness—although the most recent index of national factory activity did improve from 48.5 to 49.5 in the March report. But an ISM index reading below 50 indicates a contraction in the manufacturing sector, while a reading above 50 would indicate an expansion.
Inflation prospects remain somewhat uncertain, although there are some signs of possible firming. I don’t believe that the Fed will tighten money supply until it sees “the whites of the eyes of inflation.” At this point it seems like there are still too many disinflationary or deflationary impulses around the world for inflation to be a major concern at this time.
Rate Hike Ahead?
Looking further out, I believe there is about a 50 percent chance—essentially a coin flip—that the Fed will make a move at its June 15 meeting.
Call it “heads” that that the Fed moves again at that time—and tails that they don’t. By that time, energy prices may have stabilized, and we may be seeing more strength in wages and housing prices (which feed into inflation statistics).
With inflation getting closer to the Fed’s 2 percent goal, the Fed may find the June meeting a good time to make their second move in order to maintain credibility with the markets.
June may also be the best possible timing given that, as we move through the summer and fall, the election will become a more prevalent, and possibly destabilizing, event.
I also believe the Fed would really like to continue this very slow exit from the extraordinary policy measures taken since the financial crisis. The efficacy of current policy is now up for debate.
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