Market Commentary - Focus

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Economic Outlook - APRIL 2016

As widely expected the Federal Open Market Committee (FOMC) left the fed funds target range at 0.25 percent to 0.50 percent at their meeting on April 27th while they further consider the risks in the medium term. Their action was widely anticipated, as Federal Reserve Chair Janet Yellen laid out the challenges in assessing the economic data in a speech on March 29th. Yellen said the headwinds facing the U.S. economy included “weak foreign activity, dollar appreciation, a pace of household formation that has not kept up with population and income growth and so has depressed homebuilding, and productivity growth that has been running at a slow pace by historical standards since the end of the recession.” The potential impact on the economy from financial and international developments seemed to be the largest concern for Yellen. Also data related to inflation has been less persuasive to some Committee members. The base case for the economy remains one of modest growth over time during which the FOMC will gradually remove policy accommodation.


In spite of lackluster growth in the first quarter (the first estimate of GDP was 0.5 percent), the economy has continued to chip away at resource slack. It is difficult to square the estimated weakness in economic activity with the job market. Weekly jobless claims have fallen to their lowest level since 1973 and job growth has continued to exceed 200,000 through the first three months of this year. The rise in the labor force participation rate over the past six months suggests that the job market is finally pulling discouraged workers off the sidelines. There are also some signs that wages and salaries are rising more consistently. Some will be from mandated or voluntary increases in minimum wages, but competition for skilled workers, as pointed out in the most recent Fed Beige Book is also a factor for increasing labor costs.




Of the Fed’s dual mandate, full employment and stable inflation, it is the latter that bears watching. While the strong dollar has abated slightly, it remains higher against most currencies. When combined with sluggish global demand and excess capacity in many product markets, pricing power remains under intense pressure. While inflation is unlikely to surge anytime soon, the combination of recent higher energy prices and the weaker dollar, along with higher labor market conditions should nudge it closer to Fed’s target over the next year. It may take several months of stronger evidence of pricing pressures before the Committee is less uncomfortable with the inflation environment. The “powers to be” at the FOMC appear to be more comfortable with the risk of being behind the curve than it is with acting too early. An overshoot of inflation is perceived to be somewhat easier for monetary policy to adjust than the persistent undershoot of recent years.




Despite the robust performance of the labor market and reduced market volatility, the Fed will tread cautiously, given the anemic character of recent economic data such as GDP, retail sales, and industrial production. The FOMC is waiting for confirmation that economic momentum is accelerating and inflation is trending closer to target. Thus, the Fed remains data dependent and as long as the data, markets and events do not go south, the FOMC will likely stay with its plan to continue to gradually and cautiously raise rates later this year.