Macro Commentary

There is March madness about!  In the US, that often means that people are paying close attention to their college basketball brackets –waiting and watching to see where fate overturns consensus.  Not terribly dissimilar to the investing world, it is common that the consensus opinion at the start of the contest is wrong. It was no different this week.  As we wrote in the last update, all eyes were on the Fed decision this week and the timing signal that would be sent in its choice of words.  Going into the announcement, the financial markets seemed to be pricing in “sooner rather than later” for an interest rate increase.  Alas, the consensus opinion was wrong again.

The FOMC’s action to drop the word “patient” but incorporate some language saying they want to “[see] further improvement” in labor and inflation was right in line with our thinking.  The Fed does not intend to tighten pre-emptively (i.e. extrapolating a few data points into the future), instead wanting to see enough to be sure it is time (look back on a longer string of data).  The market action the past week or two was pricing in a June-ish first rate hike.  The equity and bond market reaction after the announcement was to change expectations to September-ish (equities up, bond yields down, USD weaker).

We still believe the Fed has a desire to increase rates at some point this year and the equity market is likely to swoon in response at the time.   As we have said in the past, the timing of the first move is less fundamentally important than the pace and magnitude of the subsequent interest rate moves (basically the cumulative change).  We continue to think the Fed will move slowly and in small increments so as not to risk disrupting growth, thus we continue to be favorable on equities broadly.

So far this year, we are also seeing the impact of the divergence between the US tightening policy and the rest of the world easing – the best equity markets in local currency terms are outside the US.  With the ECB finally stepping into their QE program, it is critical that the national governments follow through with some fiscal and structural reform to keep the momentum going.  In addition, it is important to keep in mind the second-level effects of a devaluation the euro.  While there is more nuance than this simple statement, generally speaking countries that compete with Euro-area exports are facing stiffer competition these days.  Many of these countries are in emerging Asia.

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