The Federal Reserve's Punch Bowl

The Federal Reserve’s punch bowl has been out since the financial crisis and our modest and long-lasting economic expansion continues. With such a large and generous punch bowl, you would have thought by now the party would be ripping!

GDP and PCE data which came out last week show we are having a good time, but it’s a bit of a tame party. Sure, GDP in the second quarter was 2.6% and showed resilience, but the first quarter’s growth was revised down to 1.2% from 1.4%. Most economists are anticipating no better than low to mid 2% GDP growth for the remainder of 2017 and into 2018, and much of this growth can be attributed to personal consumption, which is supported by the current cyclically low rate of unemployment. It may not be a wild party, but it looks like everyone showed up!

Inflation (as measured by PCE) is the real wet blanket at this party. It came in at 0.9% which was one of the soberest prints in recent memory and well below the Fed’s target of 2.0%. The Fed still says it can see its way to higher inflation over the medium term, but the data is not yet playing along.

This tame growth and inflation data makes us wonder how fast the Fed can raise interest rates and how high they can go with rates. We agree rates have been too low for too long and this creates its own problems, including historically low levels of income on fixed income portfolios and encouraging asset bubbles. Reason enough to normalize rates over time.

Related: Can Bond Investors Still Make a Positive Return in 2017?

We anticipate the Fed will continue to gradually raise rates, but if this party continues to stay tame or even gets a little bit boring, the Fed may not need to act so fast in taking away the bowl.

Source: Bloomberg, The Financial Times