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The Federal Reserve offered a glass-half-full outlook on the U.S. economy at its policy meeting on June 19, but financial markets weren't "buying." And indeed, amid recent indications of a slowdown in manufacturing, continued softness in the labor market, and a reduction in personal spending, the Fed’s comparatively rosy view on economic growth seems markedly out of step with investor perceptions.
The central bank noted in its policy communiqué "the downside risks to the outlook for the economy and the labor market as having diminished since the fall."1 Having said that, the Fed reduced slightly its central tendency for economic growth for 2013 to a range of 2.3-2.6%2—still higher than most economists expect.3
The big sticking point for the Fed is the labor market. In the opening remarks to his June 19th press conference, Fed chairman Ben Bernanke cited "gains in private payroll employment averaging about 200,000 jobs per month over the past six months."4 But the bulk of that strength came earlier in the year; Bernanke did not address recent declines to 165,000 in April and 175,000 in May.
In accordance with the Fed's optimism is the expectation that economic growth will allow a gradual reduction later this year in the pace of the Fed's quantitative easing (QE) effort via the monthly purchase of $85 billion in longer-term Treasury securities and agency mortgage-backed securities. With the help of a reduction of fiscal restraint in 2014, Bernanke cited the possibility of an end to QE midway through 2014, consistent with the projected unemployment rate declining to 7.0%. The Fed further expects unemployment to reach 6.5% by the end of 2014, paving the way for an eventual increase in the fed funds rate in 2015.
Such optimism and the associated exit strategy for QE were not received well by investors, as stock and bond markets posted solid losses on June 19. Equity investors evidently think that the economy and the stock market need Fed stimulus more than the central bank projects. Fixed-income markets appear to have a more immediate concern: Bond investors took flight from long-term Treasuries, not knowing who would fill the Fed's buying shoes, and at what price, once the central bank allows the good ship QE to set sail.
So for all Bernanke's efforts at improving communication, and presenting a clear and unambiguous picture of the central bank's economic view and policy outlook, his pitch to financial markets fell flat. After all, transparency is best when investors like what they see.
A Note about Risk: Investing involves risk, including the possible loss of principal. The value of an investment in fixed-income securities will change as interest rates fluctuate and in response to market movements. As interest rates fall, the prices of debt securities tend to rise. As rates rise, prices tend to fall.
The opinions in the preceding commentary are as of the date of publication and subject to change based on subsequent developments and may not reflect the views of the firm as a whole. This material is not intended to be relied upon as a forecast, or research or investment advice regarding a particular investment or the markets in general, nor is it intended to predict or depict performance of any investment. This material is being provided as general information only and is not intended to be legal or tax advice. Investors should not assume that investments in the securities or sectors described were or will be profitable. This document is prepared based on information Lord Abbett deems reliable. However, Lord Abbett does not warrant the accuracy or completeness of the information. Investors should consult with a financial advisor prior to making an investment decision.