The Consumer Price Index (CPI) is a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services, and is a commonly used measure of inflation.
Watching the Fed: Disruption or Distraction?
The start of a new Fed rate hike cycle may grab investors’ attention in 2016, but investors must distinguish where it is more likely to disrupt their accustomed routine (bonds) and where it is more likely to be just a distraction (stocks). In addition, the market and the Fed remain deeply divided over the timing and pace of Fed rate hikes, and how that gap is resolved will determine the extent of the effects on the markets. As a reminder, the start of Fed rate hikes does not signal the end of economic expansions. Indeed, since 1950, the start of Fed rate hikes meant that the economy was still in the first half of the expansion.
We believe a rate hike in December 2015 remains a strong possibility. Our view remains that when the Fed does raise rates—likely in late 2015 or early 2016—that the timing of the first hike matters less than the pace of the hikes; the end point for the fed funds rate in this tightening cycle (the first since 2004) and the gap between the Fed’s own view of rates and the market’s view remain crucial.
The Federal Open Market Committee’s (FOMC) latest forecast of its own actions (September 2015) puts the fed funds rate at 1.375% by the end of 2016. As of November 23, 2015, the market (as defined by the fed funds futures market) puts the fed funds rate 0.50–0.75% lower at around 0.81% by the end of 2016. How that gap closes—between what the market thinks the Fed will do and what the Fed is implying it will do—against the backdrop of what the Fed actually does, will be a key source of distraction for markets in 2016. Our view is that the Fed will hike rates in late 2015/early 2016, and by the end of 2016, push the fed funds rate into the 0.75–1.0% range.
Fiscal Stimulus Around the Globe
In the wake of the Great Recession (2007–09), governments across the globe, in both developed and emerging markets, increased fiscal stimulus (more government spending, tax cuts, or some combination of the two) to combat the worst global downturn in 75 years. As the global economy emerged from the Great Recession over the past half-decade or so, governments reined in—and in some cases, reversed—the fiscal stimulus put into place during and after the Great Recession, most notably in developed markets. In emerging markets, fiscal stimulus continued, but at a slower pace than during the Great Recession, led by China [Figure 4].
Looking out to 2016, markets don’t expect much in the way of fiscal stimulus in either developed or emerging economies. Thus, any stimulus that is enacted would likely be viewed as a positive surprise to markets looking for any boost to global growth.
Focusing on the U.S., outside of the major entitlement programs (Medicare, Medicaid, and Social Security), U.S. fiscal policy at the federal level has been restrictive since the $787 billion fiscal stimulus plan was enacted by Congress in 2009. While there is some historical evidence that fiscal stimulus picks up in an election year, historically, the odds of Congress passing meaningful fiscal stimulus that would impact growth before 2017 is low. However, the election of Paul Ryan (R-WI) as Speaker of the House in October 2015 increases the chances that market-friendly legislation is passed into law in 2016.
Adding Global Growth to the Agenda
We believe that economic growth outside the U.S., in both developed and emerging economies, may accelerate modestly in 2016, albeit from fairly low growth in 2015. A key differentiator is likely to be the role commodities play in a given economy. While economic growth in developed economies (generally commodity consumers) accelerated in 2014 and 2015, emerging market economies have, in aggregate, been decelerating since 2010. Though many factors are at play, China has an outsized role as the marginal consumer of commodities. While the U.S. economy is becoming increasingly sensitive to global matters, on balance, the U.S. economy is still among the least export sensitive of any major economy.
John Canally is chief economic strategist for LPL Financial