All in all, we expect the wealth effects of lower energy costs, low inflation and low interest rates to support consumption ahead.
Why then is the Fed seeming to back away from its hitherto sanguine view of US economic prospects?
We believe the latest Fed commentary tells us that policymakers seem prepared to fall behind the bond market’s pricing of future inflation and interest rate expectations.
In our view, this strategy of potentially allowing US inflation to run above the medium-term target of 2% as a mechanism to counterbalance global disinflationary forces is not without risk.
Fed policymakers are no doubt conscious that their counterparts in the European Central Bank and Bank of Japan are burrowing down the rabbit hole of negative interest rates.
In consequence, the Fed will not want to appear too aggressive in widening the interest rate differential with other markets, thus posing more US economic risks.
In the short term, we expect the accommodative stance of central banks to continue in light of global growth and financial market developments. We expect there is enough fodder to keep investors engaged, which should support risk assets in the short term.
We also note that recent economic data in the US has provided more reassurance to investors, as manufacturing surveys show signs that the downdraft appears to be slowing.
All that said, the inflation question is unlikely to disappear, particularly if core inflation continues to drift higher.
At some point, markets may have to reassess their view of longer-term inflation expectations, whereupon again we are likely to see a return to more volatile times.