Market Yawns as Fed Tees Up Balance Sheet Runoff
Easy financial conditions keep the Fed on course despite a string of weak inflation readings.
Second-quarter U.S. real gross domestic product (GDP) growth was solid at 2.6 percent annualized, rebounding from a soft 1.2 percent reading in the first quarter. We anticipate that personal spending will continue to propel above-trend real GDP growth in coming quarters, supported by strong gains in household income and net worth.
The U.S. labor market has strengthened further, with robust payroll gains of 209,000 in July. The 12-month moving average stands at 180,000, roughly double the amount needed to keep the unemployment rate steady. Indeed, the unemployment rate has fallen by 0.6 percentage point over the past year to 4.3 percent, and we expect further declines going forward. Inflation and wage gains have disappointed in recent months, however, with core personal consumption expenditure (PCE) inflation slowing from 1.9 percent to 1.5 percent year over year between February and June. While transitory factors account for some of the weakness, inflation should be accelerating, not slowing. Nevertheless, the Fed pressed forward with a quarter-point rate increase at its June meeting, and projected another hike in 2017, plus three more in both 2018 and 2019. The Fed’s forecasts show that it expects inflation weakness will not persist beyond 2017.
A key reason the Fed is shrugging off soft inflation data is that measures of broad U.S. financial conditions—which incorporate factors such as short- and long-term interest rates, credit spreads, equity prices and the exchange value of the dollar— have eased even as the Fed has raised rates (see chart, bottom right). There has also been a benign market reaction to the Fed’s pre-announcement of its balance sheet normalization strategy, which we expect to be implemented starting in October. The fact that growth-friendly financial conditions still prevail despite Fed tightening— and diminished odds of fiscal easing—has given the Fed confidence that it can stick to its plans to gradually raise rates and shrink its balance sheet without damaging the economy. We see the next Fed hike in December.
The ECB’s path is arguably more treacherous than the Fed’s because markets are more uncertain about the future of the ECB’s asset purchase program. Purchases are currently scheduled to continue at a pace of €60 billion per month through 2017. We expect the ECB will announce a reduction in the purchase pace to €40 billion through at least mid-2018, effective in January, later this fall. With the tide of central bank liquidity receding, markets are due for an increase in volatility.
Booming Markets Have Lifted U.S. Household Net Worth to an All-Time High
Extraordinary monetary accommodation has boosted asset valuations and lifted household net worth to an all-time high, which should help support consumer spending.
Source: Haver Analytics, Federal Reserve Board, Guggenheim Investments. Official data through 3.31.2017. Guggenheim estimates through 7.15.2017. Shaded areas indicate recession.
Financial Conditions Have Eased Despite Fed Tightening
Market indifference to Fed tightening has given policymakers confidence to continue normalizing policy.
Source: Bloomberg, Goldman Sachs, Guggenheim Investments. Data as of 7.15.2017. Shaded areas indicate recession.
—Brian Smedley, Head of Macroeconomic and Investment Research; Maria Giraldo, CFA, Director
Important Notices and Disclosures
This article is distributed for informational purposes only and should not be considered as investing advice or a recommendation of any particular security, strategy or investment product. It contains opinions of the authors but not necessarily those of Guggenheim Partners or its subsidiaries. The authors’ opinions are subject to change without notice. Information contained herein has been obtained from sources believed to be reliable, but are not assured as to accuracy. Past performance is no guarantee of future results.
Investing involves risk. In general, the value of fixed-income securities fall when interest rates rise. High-yield securities present more liquidity and credit risk than investment grade bonds and may be subject to greater volatility. Asset-backed securities, including mortgage-backed securities, may have structures that make their reaction to interest rates and other factors difficult to predict, making their prices volatile and they are subject to liquidity risk. Investments in floating rate senior secured syndicated bank loans and other floating rate securities involve special types of risks, including credit risk, interest rate risk, liquidity risk and prepayment risk. Guggenheim Investments represents the following affiliated investment management businesses of Guggenheim Partners, LLC: Guggenheim Partners Investment Management, LLC, Security Investors, LLC, Guggenheim Funds Investment Advisors, LLC, Guggenheim Funds Distributors, LLC, Guggenheim Real Estate, LLC, GS GAMMA Advisors, LLC, Guggenheim Partners Europe Limited, and Guggenheim Partners India Management. ©2017, Guggenheim Partners, LLC. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Guggenheim Partners, LLC.
VIDEOS AND PODCASTS
Maria Giraldo, CFA, Managing Director, Investment Research, and Evan Serdensky, Director, Portfolio Management, provide our macro and markets outlook.
U.S. Economist Matt Bush analyzes the latest Fed announcement and labor and inflation data, Investment Strategist Maria Giraldo discusses credit risk while the Fed tightens, and Managing Director Chris Keywork updates on the bank loan market.
Guggenheim Investments represents the investment management businesses of Guggenheim Partners, LLC ("Guggenheim"). Guggenheim Funds Distributors, LLC is an affiliate of Guggenheim.
Read a prospectus and summary prospectus (if available) carefully before investing. It contains the investment objective, risks charges, expenses and the other information, which should be considered carefully before investing. To obtain a prospectus and summary prospectus (if available) click here or call 800.820.0888.
Investing involves risk, including the possible loss of principal.
*Assets under management is as of 03.31.2022 and includes leverage of $20.0bn. Guggenheim Investments represents the following affiliated investment management businesses of Guggenheim Partners, LLC: Guggenheim Partners Investment Management, LLC, Security Investors, LLC, Guggenheim Funds Distributors, LLC, Guggenheim Funds Investment Advisors, LLC, Guggenheim Partners Advisors, LLC, Guggenheim Corporate Funding, LLC, Guggenheim Partners Europe Limited, Guggenheim Partners Fund Management (Europe) Limited, Guggenheim Partners Japan Limited, GS GAMMA Advisors, LLC, and Guggenheim Partners India Management. Securities offered through Guggenheim Funds Distributors, LLC.
Guggenheim Investments. All rights reserved.
Research our firm with FINRA Broker Check.
• Not FDIC Insured • No Bank Guarantee • May Lose Value
This website is directed to and intended for use by citizens or residents of the United States of America only. The material provided on this website is not intended as a recommendation or as investment advice of any kind, including in connection with rollovers, transfers, and distributions. Such material is not provided in a fiduciary capacity, may not be relied upon for or in connection with the making of investment decisions, and does not constitute a solicitation of an offer to buy or sell securities. All content has been provided for informational or educational purposes only and is not intended to be and should not be construed as legal or tax advice and/or a legal opinion. Always consult a financial, tax and/or legal professional regarding your specific situation. Investing involves risk, including the possible loss of principal.