The FOMC soothed markets by reassuring that it would remain accommodative, maintaining its projection for the timing of the first interest-rate cut and sticking to its existing taper timeline. The Fed also pledged to communicate the mechanics of any dialing down of its accommodative policy stance, if and when it’s necessary.
The Fed’s full-year forecast was hurt by harsh winter weather.
The Fed recognizes that the economy has rebounded in recent months, but lowered its GDP expectations for 2014 because of a terrible first quarter. The Fed now expects the economy to grow between 2.1% and 2.3% this year, versus the 2.8% to 3% growth it expected in March. However, that doesn’t mean the Fed expects slower growth in the next few quarters.
No imminent change to monetary policy.
Despite recent signs of growth and inflation, the Fed is not in a rush to change its accommodative stance. Fed Chair Janet Yellen said given the uncertainty in the markets, there is no definitive way to determine a timeline for tightening after the unwinding of bond purchases is complete.
More importantly, the median forecast for the fed funds rate over the longer term is lower than it was in March—3.75% instead of 4%. Even after the US economy hits maximum employment and inflation eclipses the 2% target, the Fed may keep the target rate below what’s considered normal for a long time.
Taper timeline remains intact.
The Fed opted to continue tapering its bond purchases by $10 billion at each FOMC meeting, split evenly between Treasuries and mortgage-backed securities. It’s now down to $35 billion in purchases for July.
Any dialing down of accommodative policy will be measured and thoughtful.
When the Fed decides to tighten monetary policy, it will be slow and deliberate to avoid rocking markets. Further, Yellen explicitly said that the Fed will communicate exactly how the unwinding will work before the end of 2014, but the pace and timing is still unclear.
What It Means for Investors
The Fed’s announcement, while it contained no surprises, was important in underscoring its commitment to remaining highly accommodative. This was particularly significant given that recent rhetoric from Mark Carney that the Bank of England might be raising rates sooner than the market expected. Plus, we’re seeing signs that inflation has increased recently in the United States, with the Consumer Price Index rising 0.4% in May after a 0.3% increase in April.
We remain in an environment of financial repression, which has reshaped the investing landscape. Investors need to ensure that they’re not overexposed to asset classes that have been rendered less attractive from a risk/reward perspective, namely cash and core fixed income. At the same time, investors need adequate exposure to risk assets such as high-yield bonds, convertible bonds and stocks to meet their goals.
However, with the Fed continuing to taper and coming closer to dialing down accommodation, expect more volatility and buy risk assets on the dip.