RANDY FREDERICK: The May FOMC meeting went pretty much as expected, with virtually no surprises. Liz Ann Sonders, Schwab’s chief investment strategist, joins me for the May 15 Schwab Market Snapshot to discuss what we can expect from the Fed in the coming months. Welcome back, Liz Ann.
LIZ ANN SONDERS: Thanks, Randy. And thanks, everybody, for tuning in.
RANDY: So, Liz Ann, there was very little fanfare around the May FOMC meeting, but now the expectations for a rate hike at the June meeting have been hovering around 100%. So what is it that has driven the consensus so high this far in advance of that meeting?
LIZ ANN: Well, probably, the most relevant thing that has happened is what we have been hearing from Fed speakers. So in this era of greater transparency by the Federal Reserve, you not only have Yellen out making comments—but a whole cacophony of Fed speakers—who have all been guiding the market in the direction of expecting a June rate hike. And then, of course, you have the economic data, which has improved. So you had a very weak, seasonally, typically weak first quarter from which estimates have really picked up into the second quarter.
And then, most importantly, the jobs data has improved. And, remember, the Fed has a dual mandate, so inflation and jobs are the two areas of focus for them. And we’ve seen a pickup again in jobs growth after the prior month which was fairly weak and the unemployment rate back down to under about 4½ %. So I think those economic conditions have pushed the market in a direction of believing that it’s a—basically a done deal for June. And it’s our view that that’s the right move to make.
RANDY: Okay. Well, assuming we do get a rate hike in June, what are your thoughts of the timing and the pace of rate hikes beyond the June meeting?
LIZ ANN: So we think there is a decent likelihood that we get at least another rate hike. Now, the Fed is not beholden to only changing rates in the meetings that have a press conference. So that would be the March meeting, the June meeting, the September meeting*. But I think at this stage in the game, if they had their druthers, they would like to do it during a meeting that has a press conference, so they can explain the move.
So our best guess is we’ll likely see a move in September. Beyond that, I think it’s a function of their thinking on the balance sheet. So we’re guessing that if they start to talk to us and communicate a bit more about the plans to shrink the balance sheet, that they may not start to do that during a meeting at which they also raise interest rates. So I think September is fairly likely, but they may stop there, and then refocus their attention on the balance sheet.
RANDY: Well, since you mentioned the balance sheet, that’s my next question. We’ve been hearing an awful lot about the size of the Fed’s balance sheet, and, actually, when they might start reducing it. Why is that an important topic to the equity markets?
LIZ ANN: Well, it’s a form of tightening. In fact, you’re probably going to hear a lot more looking ahead at this transition from QE to QT, so quantitative easing to quantitative tightening. I think part of the reason why the Fed feels comfortable starting to discuss how they plan on shrinking the balance sheet is that even though the Fed has raised rates three times, possibly four as of June, financial conditions have actually loosened during that period of time.
So there’s a number of indexes that I know both you and I follow, Randy, that measure whether financial conditions are loose or tight. And even though the Fed has been tightening, financial conditions have loosened. And I think that does give them some comfort. So that is what I would key off of. Less about what the Fed is actually doing, but the implications it is having for financial conditions. And Wall Street Journal
just did a survey of economists recently, and they found that about a 15% reduction in the Fed’s balance sheet is the equivalent of about 25 basis points—another reason to think that they might not pair the two together. So best guess June hike, another one thereafter, and then the attention, at least in the near-term, will focus on the balance sheet.
RANDY: Yeah, I think that’s a very good point. Thank you so much, Liz Ann. That’s all the time we have for today.
Listen, if you want to read more from Liz Ann, you can do that in the Insights section of Schwab.com. You can follow Liz Ann on Twitter @LizAnnSonders
, and, of course, you can always follow me on Twitter @RandyAFrederick
. We’ll be back again. Until next time, invest wisely. Own your tomorrow.
* Note: 2017 FOMC meetings associated with a Summary of Economic Projections and a press conference by the Chair take place in March, June, September and December.