The U.S. Federal Reserve (Fed) today announced it is holding the federal funds rate target at 0.75%-1.00%—a decision that was not a surprise. The Fed still remains on track to make two rate hikes sometime later this year.
Why no interest rate change now?
Economic data released before today’s meeting indicated that Real Gross Domestic Product (GDP) for the first quarter of 2017 was just 0.7%—much lower than anticipated, and the slowest growth in three years.1 Jobs growth also slowed in March and the unemployment rate dropped to a 10-year low of 4.5%.2
While it downplayed recent economic weakness, the Fed emphasized the robust labor market, noting “job gains were solid, on average, in recent months, and the unemployment rate has declined.” Fed Fund Futures (which tracks the likelihood of a Fed rate hike) estimates that the probability of the Fed hiking rates another 25 bps at its June meeting shot up from 70% to 90% after the announcement. Most asset classes have had a benign reaction to the Fed statement as its comments were very in line with expectations.
The Fed expects the economy to expand at a moderate pace with inflation running close to the Fed’s 2% target. The Fed will also take a wait and see approach to the impact of President Trump’s fiscal policies on tax, spending and regulation.
U.S. dollar up
The U.S. dollar reacted positively ahead of today’s announcement, hitting its highest level in more than six weeks against the yen.
What about your MD portfolio?
At MD, we believe that the U.S. economy remains strong, and we continue to maintain an overweight to the U.S. compared to other developed markets. We remain fully unhedged in our U.S. portfolios (in other words, we have not taken measures to protect against a U.S. dollar decline). The Fed will likely raise rates at least two more times in 2017, and the outlook for the U.S. dollar relative to the Canadian dollar should remain positive.
We continue to maintain a lower exposure to the energy sector in our Canadian, dividend and U.S. portfolios due to the increased volatility (risk) of energy stocks, and we see other opportunities that provide better return on capital. While we source our ideas in our funds and pools through bottom-up, fundamental stock selection, our lower exposure to energy should also benefit benchmark performance. Future Fed increases will put pressure on the U.S. dollar, pushing the price of oil down.
We expect today’s Fed announcement will have little impact on the overall positioning or performance of your portfolios.