CBSI-TL-C-Mission-Accomplished

Economic and Market Insights June 9, 2017

By Scott Colbert, CFA Chief Economist, Director of Fixed Income The Commerce Trust Company

Federal Reserve’s Perspective Is Largely “Mission Accomplished”

With a 4.3% unemployment rate and inflation moving towards or hovering around 2%, the Federal Reserve (Fed) is likely giving itself a pat on the back this month for reaching its target goals for the economy. The media widely reports that the Fed is tasked by Congress to operate under a so-called “dual mandate,” which directs the board “to promote effectively the goals of maximum employment and stable prices.” There is a third mandate, rarely mentioned, which calls for “moderate long-term interest rates” as well. All considered, the legislature provides the Fed with a simple roadmap. Despite these three often contradictory objectives, the Fed could reasonably argue it has hit the bull’s-eye, perhaps like never before. And because of its success with the hard data, most market experts believe that the next quarter-point interest rate is a foregone conclusion at the Fed’s June 13-14 Federal Open Market Committee meeting. Well….unemployment is at a 16-year low. And hourly wages are growing consistently at an annualized pace of 2.5% or better. With unemployment low, wages will typically rise even further, and rising wages generally lead to a bit more inflation. And let’s face it, a sub-1% short-term interest rate and a 3% 30-year-Treasury rate is rather obviously a very favorable interest rate environment. So the Fed wants to gradually reduce what it considers exceptionally accommodative monetary policy while it can and pre-empt a material overshoot of either inflation or employment or interest rates down the road. So why raise rates when everything is coming up roses?

And economic growth is forecast to actually accelerate a bit over the back three quarters of the year with stock prices hitting record highs, consumer and business confidence elevated and home prices back to pre-crisis levels. So it’s likely the unemployment rate will continue to drift lower and perhaps put further pressure on inflation. We doubt this will be the last rate move, either. We expect one more move up this year before the Fed turns its attention to its gigantic balance sheet grown by all the additional money it created during the financial crisis. What gives the Feds pause? Job growth has slowed, with last week’s report coming in at about 138,000 new jobs. And the new jobs were also concentrated in lower-paying areas, with leisure and hospitality adding most of the positions. Most of the decline in unemployment has simply been because working-age folks are leaving the job force (demographics) as the labor force participation rate edges lower. Fortunately, the employment-to-population ratio increased to 60.2 percent, its best showing of 2017 and the highest level since February 2009. And jobs are finally skewing sharply to full- time positions, which grew by 480,000, while the part-time rolls tumbled by 370,000. So even though the Fed has already hit the bull’s-eye, it knows the economic landscape is always changing, and to keep its darts in the middle of the board, it knows it has to always adjust course a bit. And that adjustment comes with a higher short-term rate in June.

Takeaways

 Weaker first-quarter growth and lower-than-anticipated inflation appear to be temporary conditions as the overall economic outlook remains very positive.  In order to keep the economy on target, the Fed will continue to nudge rates higher and eventually begin to focus on its balance sheet, swollen by years of money creation.  While unemployment is low, a lot of that is due to demographic factors, and wage growth has still not broken out into an inflationary problem.  The Fed does not rest on its laurels. It is tasked to anticipate the economy and believes it can gradually push back now since the economy’s path is on target and its mandates have been primarily obtained.

The 2017 investment commentary is a special report designed to provide investment information on economic markets for Commerce Brokerage clients. It is intended to provide general information only and reflects the opinions of The Commerce Trust Company’s Investment Policy Committee.

The Commerce Trust Company is a division of Commerce Bank. Commerce Brokerage Services, Inc., member FINRA and SIPC, and an SEC registered investment advisor, is a subsidiary of Commerce Bank.

This material is not a recommendation of any particular security, is not based on any particular financial situation or need, and is not intended to replace the advice of a qualified attorney, tax advisor or investment professional. The information in this commentary should not be construed as an individual recommendation of any kind. Strategies discussed here in a general manner may not be appropriate for everyone.

Diversification does not guarantee a profit or protect against all risk. Past performance is no guarantee of future results, and the opinions and other information in the investment commentary are as of June 9, 2017.

Commerce does not provide tax advice or legal advice to customers. Consult a tax specialist regarding tax implications related to any product or specific financial situation. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed. All expressions of opinion are subject to change without notice depending upon worldwide market, economic or political conditions.

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