| Jun. 27, 2019
FAQs on the Markets and Economy
What is the Fed’s next move with the federal funds rate?
The Fed concluded its two-day meeting on monetary policy on June 19 and left interest rates unchanged, as expected.
It does not plan to change interest rates this year, but plans a cut next year (chart). This is based on the median of all the members of the FOMC.
That said, there is a large minority of FOMC members who would like to see a cut this year. One member would like to cut rates by 25 bps, and seven members would like to cut rates by 50 bps this year (eight would like to keep rates unchanged, and one member would like to increase rates by 25 bps). Clearly, the Fed is divided.
The federal funds futures market implies a cut as early as the July 30 meeting.
We at City National Rochdale believe the Fed will lower interest rates by 25 to 50 basis points this year, with the first move not happening before the September meeting. We think the Fed will want to see more economic information before making a decision. The U.S. economy is generally in good shape; the concern is with the slowing pace of the global economy and trade tensions.
Why does inflation continue to stay so low?
Back in 2012, the Fed decided it wanted to target inflation at 2.0%, like most other major central banks around the world. Since then, inflation has been below that target and the Fed is getting frustrated.
The driving force of low inflation has been with the “Goods & Commodity” portion of the index (chart). Since 2012, the average annual change has been just .01%, while the remaining portion, “Services,” has averaged 2.5%.
The low inflation of Goods & Commodity portion is driven heavily by the global drop in commodity prices, especially oil. Back in 2012, oil had an average price of near $100 per barrel; now it is under $60. Other important commodities have also fallen in price. Fed actions will have very little impact on these global issues.
What is the status of the fiscal year (FY) 2020 state government budget cycle?
According to the National Conference of State Legislatures, 46 states begin their FY on July 1, 2019. As of June 18, 2019, 39 states either enacted an FY 2020 budget or await a signature on the budget by their respective governor.
A low number of states without an enacted budget at the onset of the FY is likely. During the FY 2019 budget cycle, only three states failed to adopt an on-time budget, a departure from FY 2018 when 10 or more states fell short of consensus.
A key catalyst underlying a “smoother” process this cycle is the economic environment and associated revenue collections, which continue to perform favorably. The National Association of State Budget Officers reports at least 28 states are on pace to exceed their revenue targets for the current FY (revising some projections higher next year as a result).
The durability of the current economic recovery, revenue volatility, and recurring spending commitments are essential considerations in the upcoming year for the state sector. Policy actions and the evolving implications of tax reform also deserve attention, but as FY 2020 approaches, most states enter with improved fiscal conditions, a credit positive.
Is the outlook for stocks still positive?
We continue to have enough confidence in the economic outlook, and see sufficient scope for earnings growth, to remain positive on U.S. Equities. For now, U.S. stocks have rallied back to record highs on the Fed’s recent openness to rate cuts, as well as optimism that U.S.-China trade negotiations will resume at this week’s G20 meeting.
However, we don’t expect the pace of recent gains to continue. With markets now fully valued, downside risks have increased somewhat and we expect volatility to remain elevated. The U.S. economic expansion is in its later stage, growth is slowing, and trade tensions remain a significant concern. As a result, profit growth is becoming more challenging.
City National Rochdale continues to be focused on higher quality and dividend-paying domestic companies, while minimizing exposure to cyclical and export-oriented sectors most affected by trade concerns and global headwinds.
Over time, we think the bull market will continue and that stock prices will move up, in-line with modest earnings growth. However, we expect the market will likely be range bound and volatile until we get more clarity on trade and the path of interest rates. A consolidation period or another pullback is also possible.
What is City National Rochdale’s investment outlook?
Given our continued positive assessment of the fundamental backdrop, we remain positive on equities in general and continue to see attractive prospects in the opportunistic fixed income class.
Still, downside risks have increased somewhat and the investment landscape is growing more challenging.
Late cycle conditions of slowing growth and greater vulnerability to policy missteps will require investors to change their approach and be more selective in their portfolios.
None of this means there are not more opportunities ahead for investors, but gains are likely to be more muted. At the same time, concerns over global growth, trade tensions, and the path of interest rates mean markets will likely continue to be subject to periodic swings in sentiment and potential pullbacks.
Our equity and fixed income research teams have made deliberate risk-mitigating changes to help fortify client portfolios against the type of market turbulence we have recently experienced, while leaving them well positioned to take advantage of opportunities that present themselves.
