Steady as she goes

There is probably a moral lesson or two in the story, but investors can draw parallels with the US economy, the Federal Reserve and its latest policy meeting: slow and steady wins the race. Or, at least, it doesn’t cripple the economy or markets.

Fed meetings are generally highly anticipated affairs, and those that correspond with the release of the Statement of Economic Projections even more so. These meetings give an insight into the Fed’s latest thinking on where it sees the economy, labour market and inflation heading over the next two years. But more important these days is these meetings also give us the famous ‘dot plot’.

This has been the slowest economic recovery in the US since World War II. The average annual pace of real economic growth has been 2.2 per cent – well below the average of 4.7 per cent for the past 10 recoveries. It is entirely possible that the picture will not be quite as bad with hindsight, as economic data is constantly revised. In fact, in the first three months of this year, the estimate of economic growth has gone from 0.2 per cent to -0.7 per cent to a final reading of -0.2 per cent. It will probably look better again after the annual revisions are conducted by the US statistical agency later in the year.

The labour market has improved significantly, and the 8.8 million jobs lost during the recession have been added back and then some, with 12.3 million jobs being created since the recession ended.

That is an average job growth of 198,000 jobs a month for 62 months. Despite the improvement, the US is only now seeing signs of wage growth as the labour market nears that mystical point of NAIRU, or the non-accelerating inflation rate of unemployment. This is the estimated level of unemployment at which inflation begins to rise because workers can demand higher wages as there is a smaller pool of candidates from which employers can choose.

As our little tortoise friend proved, slow can sometimes be good. Indeed, the moderate pace of economic expansion has kept inflation in check and monetary policy very loose, which has been good for risk assets.

As our little tortoise friend proved, slow can sometimes be good

But we are creeping towards that most hotly debated of topics: when will the Fed hike rates? The positive reaction by markets to the June statement suggested that they took the overall message as being more ‘dovish’ than anticipated; in other words, the US is further from a tightening of monetary policy than first thought. But comparing the June press release to the April release, the tone was actually more upbeat and indicative of the pick-up in economic data since the first-quarter pothole.

The market’s easy view of the Fed meeting was taken from the dot plot. This plot shows the estimates of each member of the rate setting committee of where they think the policy rate should be at the end of the next three years. More members put themselves into the category for one to two rates hikes this year than back in April. Rather than interpreting this as increasing the probability of further delays by the Fed, it could be taken as a growing consensus among its members that one or two steps on the tightening cycle are appropriate for this year.

The market pricing is still some way off the Fed’s projections, and at best, the market is looking for one rate hike this year, as shown by the Fed Funds futures. This dislocation between the market and the Fed has the potential to create volatility in the lead-up to the September meeting. This seems a perfectly natural response given just how long everyone has been waiting for this event.

However, there are a few things investors should remember about that first rate hike. It is not the first move by the Fed – or the Bank of England for that matter – that investors should be really concerned with – it is the last. Moving away from the zero-rate policy is a clear signal of economic health and an environment in which markets can move higher. That last move, however, is a deliberate attempt to slow down an overheating economy.

Furthermore, monetary policy will still be extremely accommodative and supportive of markets, and the tightening cycle is likely to be extremely gradual as the Fed will be slow and steady – much like the economy so far. One-nil to the tortoise.

Kerry Craig is global market strategist for JP Morgan Asset Management