Market Commentary - Focus

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Economic Outlook - OCTOBER 2015

Global uncertainty appeared to weigh heavily on the Federal Open Market Committee members’ minds at the September meeting and continued through October. The rationale for the Fed’s decision to stand pat at these meetings was concern over “global financial and economic developments.” The Committee worried about the world’s weakening economies spilling over in the United States’ growth and inflation outlook. Those concerns spurred the People’s Bank of China to cut interest rates and lower its required reserve requirement ratio on October 23rd, just one day after the European Central Bank signaled it will boost stimulus if needed. 


It has become evident that the U.S. is not immune to slowing global growth. As then Fed Chairman Allan Greenspan said in September 1998, it wasn’t “credible that the United States can remain an oasis of prosperity unaffected by a world that is experiencing greatly increased stress. Developments overseas have contributed to holding down prices and aggregate demand in the United States in the face of strong domestic spending. As dislocations abroad mount, feeding back on our financial markets, restraint is likely to intensify.” It appears that history may be repeating itself seventeen years later, as the world once again has too many goods chasing too few consumers, a recipe for potential deflation.


September saw the third consecutive monthly decline in the ISM Manufacturing Index and a 0.2 percent drop in industrial production, reflecting ongoing softening in the manufacturing sector. It continues to be plagued by a strong dollar and soft domestic and global demand. Part of the domestic weakness is related to a large amount of inventory building. With too much inventory on hand, producers are pulling back on new orders. Also classified as disappointing was September’s retail sales report. If automobiles are excluded, sales would have declined for the last two months in a row, suggesting consumer spending deceleration and ending the quarter on a soft note.


Inflationary pressures remain weak as significant appreciation of the dollar, pass-through from low commodity prices and still-tepid wage dynamics weigh on both headline and core measures. The core PCE (Personal Consumption Expenditures) inflation, the Fed’s preferred measure of price growth, has been stuck near 1.3 percent over much of this year and stayed there in September. However, uncertainty related to global growth prospects poses a clear downside risk to inflation, a fact of which the Fed is cognizant, thus leading the committee to fold their hands and take a pass on tightening at the September and October FOMC meetings.



With having long telegraphed its desire to get away from zero, and the current level of U.S. economic activity inconsistent with the zero-rate federal funds, the Fed kept the door open to begin normalization of rates at the December 2015 meeting in its statement issued on October 20th following the FOMC meeting. However, market expectations for the Fed to begin rate normalization continue to be pushed further out based on the continued stream of disappointing economic and soft inflation reports. Based on federal funds futures, the markets are still mostly looking past the December meeting and believe the Fed will make its first move in March 2016. Fed tightening would be inconsistent with the People’s Bank of China cutting rates and the European Central Bank’s President suggesting that the ECB would likely provide more stimulus in coming months. Economic conditions and market sentiment however, can change fast.