In one of the most highly anticipated Federal Reserve meetings in many years, the FOMC chose to leave their target for the Federal Funds Rate at the zero bound. Market expectations were roughly split on a rate increase prior to the meeting, and bonds rallied sharply after the decision was announced. The Fed is clearly concerned about two issues: 1.) low inflation and 2.) global economic uncertainty. These points were highlighted in Fed Chair Yellen’s opening statement at the post-meeting press conference. “The outlook abroad appears to have become more uncertain of late,” she said, “And heightened concerns about growth in China and other emerging market economies have led to volatility in financial markets. Developments since our July meeting including the drop in equity prices, the further appreciation of the dollar, and a widening in risk spreads have tightened overall financial conditions to some extent. These developments may restrain U.S. economic activities somewhat and are likely to put further downward pressure on inflation in the near term.”
Our house call all year has been that inflation will drive monetary policy decisions, and the current low levels of inflation give the Fed ample reason to keep rates low. Below is a chart (courtesy of Strategas) that we published in our Q2 fixed income commentary showing steadily increasing inflation before the first rate hike in the last tightening cycle of the early 2000s. Today, inflation is still trying to find a bottom, with Core PCE running at only +1.2% year/year. The bottom line is that rates are unlikely to break out of the range we’ve been in during 2015, and that the strategy of owning bonds of varying maturities to capture yield and roll-down should continue to pay off.