The magnetic compass was invented by the Chinese around 206 B.C., interestingly, not for the purpose of finding direction. Historians believed it was first used for fortune telling until appropriated by the military for navigation between the 9th and 11th centuries. Today, investors in many ways consider the monetary policies and forward guidance of the Federal Reserve (Fed) as a sort of compass for global financial markets. In that sense, the Fed holding off the beginning of a tightening cycle in September points to its reservations about where the global economy is going at a time when markets are being unanchored by Chinese selloffs.
The Fed’s ending zero interest rate policy is easily one of the most highly anticipated and debated central bank decisions since the financial crisis. Falling inflation expectations, though deemed transitory, appear to be one of the key reasons this time why the Fed hesitated in removing monetary accommodation despite a broadly improving domestic economy. While some believe the Fed is already behind the curve on normalizing interest rates, a rate hike before the end of the year is still highly probable.
Markets Lack Bearing
With the timing of the Fed hike still up for debate, we expect more market volatility ahead. The extraordinary fluctuations that began in late June have somewhat subsided, but tensions about China’s decelerating growth and its impact on the overall state of the global economy linger. Economies that depend on commodity exports—such as Brazil, Canada and Australia—are feeling the effects the most. Chinese policymakers provided some relief with support measures and promises for more, but market calm will probably be tenuous until global growth picks up.
For now, we see interest rates rising, though we expect them to climb slowly and remain low for a long time. Staying on our path, we favor a portfolio tilted toward equities, select credit, tax-exempt bonds and inflation protection through Treasury Inflation-Protected Securities (TIPS). Recent selloffs have revealed some pockets of value, such as European equities, but we are cautious toward U.S. Treasuries and commodities.