Mission Accomplished

ECONOMIC & MARKET INSIGHTS

Federal Reserve’s Perspective Is Largely “Mission Accomplished” By: Scott M. Colbert, CFA ®

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.”

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ECONOMIC & MARKET INSIGHTS

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. So why raise rates when everything is coming up roses? 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

ECONOMIC & MARKET INSIGHTS

monetary policy while it can and pre-empt a material overshoot of either inflation or employment or interest rates down the road. 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

ECONOMIC & MARKET INSIGHTS

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.

ECONOMIC & MARKET INSIGHTS

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. Past performance is no guarantee of future results, and the opinions and other information in the commentary are as of June 9, 2017. This summary is intended to provide general information only and is reflective of the opinions of Commerce Trust Company. 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. Diversification does not guarantee a profit or protect against all risk. Commerce does not provide tax advice or legal advice to customers. Consult a tax specialist regarding tax implications related to any product and 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.

ABOUT THE AUTHOR

SCOTT M. COLBERT, CFA ® Executive Vice President, Chief Economist and Director of Fixed Income The Commerce Trust Company

Scott is the chief economist and director of fixed income management with Commerce Trust Company. He joined Commerce in 1993 and has investment responsibilities for over $19 billion in fixed income assets. Scott directly manages the Commerce Short- Term Government and the flagship Commerce Bond strategies. Scott received his bachelor of science degree in nuclear engineering from the University of Cincinnati in 1986 and received his master of business administration from Xavier University in 1988. He has been both a director and president of the Chartered Financial Analyst Society of St. Louis.

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