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Portfolio > Portfolio Construction

Advisors Downplay Fed’s Interest Rate Decision

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Maybe the market should have taken the Fed at its word, that it would raise interest rates only after it had seen “further improvement in the labor market” and was “reasonably confident that inflation will move back to its 2% target,” and not have been so uncertain about today’s Fed decision beforehand.

Even though unemployment fell in August, to 5.1% from 5.3% in July, inflation also declined, for the first time since January. Consumer prices dropped 0.1%; excluding food and energy prices, they rose at a 1.8% annualized rate — still below the Fed’s 2% target.

The Fed meeting was a non-event. The cental bank maintained the near zero rate policy it put it place almost seven years ago, but today it gave another reason for deciding against a rate hike: “developments abroad,” primarily the downturn in China’s financial markets and economy, which Chair Janet Yellen referenced in her press conference afterward. 

“Recent global economic and financial developments may restrain economic activity somewhat and are likely to put further downward pressure on inflation in the near term,” the Fed said in its statement.

Still, 13 of the Fed’s 17 policymakers — which include the Fed chair, Fed governors and five Fed bank presidents — predicted the central bank would raise rates by at least 0.25% this year. (There are two more FOMC meetings — in October and December.) Richmond Fed President Jeffrey Lacker dissented from today’s FOMC dissension, voting for an immediate hike.

Vanguard agreed with that majority opinion. In a statement following the FOMC meeting, Vanguard said, “We believe a take-off in 2015 is warranted and continue to stress our view of low and slow.”

Although the timing of the Fed’s next rate move remains unknown the direction is not. 

“We know the next move in interest rates will be up,” said Joy Kenefick, a managing director at Wells Fargo Advisors. “The timing and pace has been the unknown and will continue to be.”

Jim O’Sullivan, chief U.S. economist at High Frequency Economics, agreed. “There is no clear signal” about when the Fed will tighten, O’Sullivan wrote in a note following release of the Fed’s policy statement.

Kenefick said she will be reminding clients “that any debt restructuring or financing needs they have will be better secured sooner rather than later,” but not much beyond that.

Financial advisors and economists we heard from after the Fed announcement said they are not recommending any changes to portfolios currently or in anticipation of a Fed rate hike.

“Money managers have no reason to change strategies,” said Robert Brusca, chief economist at Fact and Opinion Economics. “Basically nothing happened. What do you do when nothing happens?”

“I do not advocate many ANY changes to a client’s portfolio just because of a minute change in interest rates,” wrote Gilbert Armour of Sage Point Advisors in San Diego. “Too much emphasis is being placed on the significance of this event.”

Kevin Couper, based in Clark, New Jersey, said, “Most advisors have been preparing for interest rates to be raised for years. Asset allocation is key here – to stick to your portfolio guidance, rebalance when necessary and tax harvest where applicable.”

He’s also sticking with some actively bond funds that are “already set up to managing rising rates” whose portfolio managers are able “to sell maturing, lower yielding positions” and “renew into larger yielding positions as rates rise.”

J.J. Burns of J.J. Burns & Co. in Melville New York, said he won’t be making any changes to clients’ portfolios unless “there are disparate results in asset class performance which would require rebalancing.”

Unlike some advisors, Burns said it’s likely that longer-term rates would decline further because the Fed controls only short-term rates and global investors are attracted to U.S. bonds because they currently have the “highest rates” of any bonds in developed markets.

After the Fed’s decision Thursday the yield on Treasury bills turned negative while the yield on the 2-year Treasury note fell to 0.68% from 0.81% at Wednesday’s market close and the yield on the 10-year Treasury dropped to 2.22% from 2.30%. Treasury prices, which move in the opposite direction of yields, rose. Stock prices fell slightly — down 65 points on the Dow and five points on the S&P 500.

While the Fed made no move on interest rates it did revise its economic projections for 2015 through 2018, but none of the revisions argued for a near-term rate hike. Its median projections for 2015 GDP rose to 2.1% from the 1.9% it projected in June and for unemployment the outlook fell to 5% from 5.3%. Its inflation outlook remained muted, with the median personal consumption expenditures (PCE) forecast to rise 0.4% increase, down from 0.7% previously; excluding food and energy,the PCE was projected to increase 1.4%, up from 1.3%.

 –Related on ThinkAdvisor


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