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The Fed Coasts Along

By Linda McDonough on May 3, 2017

I’m teaching my newly permitted son to drive. Any parent who’s been through this harrowing process knows how distressing it can be to sit in the passenger seat with your teenager driving. Interestingly enough, it’s not the constant bellowing of directions; slowdown, watch out- there’s a 1.Dog 2. Pedestrian 3. Object (choose your pick), that triggers the gray hair.

The worst part is the pause between instructions. It’s the quiet side street block or the sparse Sunday morning highway where little direction is given that really freaks me out.

I think investors are like this. As a group, the stock market is a natural worrier and likes it when the Fed (the supposed driver of the economy) is sitting upright in the driver’s seat barking out instructions.

Yet the economy seems to be in a coasting phase right now. Certainly, the Fed, who will unveil its current interest plan today, seems to be on cruise control. Janet Yellen readily concedes she’s ready to enjoy the view from the backseat for a bit.

Remarks from a speech in early April illustrate this sentiment. Yellen explained that the Fed’s role right now is to let “the economy kind of coast and remain on an even keel, to give it some gas, but not so much that we’re pressing down hard on the accelerator.”

The Fed raised interest rates at its March meeting one-quarter of a point to a range of .75-1.00 percent. Although the group signaled it would like to raise rates two more times before the end of the year, it will likely skip a raise at this meeting.

A string of subdued economic reports reinforce the Fed’s watch and wait stance. The data have some fretting that the economy is sputtering out. Gross domestic product crept up at a .7% annual rate in the first quarter, less than expected and down from 2.1% in the fourth quarter. Inflation, as measured by the consumer price index, dropped .3% from the prior month, a tepid reading.

But economists point out that an odd statistical quirk called “residual seasonality” is influencing first quarter data.  First quarter production numbers have been notoriously bad predictors of annual growth. In the past five years, first quarter GDP has shown an average of 1.1% annual growth. This subdued growth was then followed by three-quarters showcasing higher 2.5% growth.

Residual seasonality simply means that the economists at the Bureau of Labor Statistics, who compile this data, are not accurately adjusting data for seasonal differences. If the first quarter estimates are coming in too low, BLS is adjusting growth too dramatically for weather related issues. Why or how this is happening is fodder for another article but safe to say, the Fed is not worried that a softer than expected first quarter GDP is a harbinger of doom.

A different view is simply that the economy is coasting along. Instead of worrying that the Fed needs to step on the gas (lower rates) to propel economic growth or that it needs to lay on the brakes (raise rates) to slow growth, my estimate is that the economy is at a good cruising speed and needs little interference to keep it on the right track.

Just as a parent sitting quietly in the passenger seat bites his nails at every corner, I understand that investors are worried the Fed will miss the economic equivalent of a bend in the road and hit a wall.

Instead, I advise investors to get in the back seat and enjoy the ride.

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