The upcoming Federal Open Market Committee (FOMC) meeting has drawn quite a bit of attention amid increased speculation that the Federal Reserve may start signaling its long-awaited move to increase rates. Retail sales were quite strong in August and the positive reaction to Apple's upcoming product launches dominated corporate news. The geopolitical backdrop did not seem to affect the markets, with President Obama's statements about ISIS containing few surprises, tensions between Russia and Ukraine remaining on the back burner and reactions to the upcoming Scottish independence vote relatively muted.
SIGNALING A SHIFT
All eyes will be on this week's FOMC meeting, with many observers expecting the central bank to drop the phrase “considerable time” when discussing how long it intends to keep the fed funds rate anchored at zero. Should it do so, it would give the Fed more flexibility in its approach to monetary policy and would signal that rate increases would likely begin next year. Partially as a result of this speculation, and in part to due continuing evidence of economic strength, U.S. Treasury yields advanced last week, with the yield on the 10-year Treasury rising 17 basis points to 2.61%.
The U.S. economy continues to be stronger than other regions. The eurozone economy remains troubled, and the turmoil in Ukraine and related sanctions against Russia are holding back growth in that region. To be sure, recently announced easing measures by the European Central Bank (ECB) should be a positive for growth, but the near-term outlook remains uncertain. At the same time, Japan's economy is struggling. In comparison, we believe the United States is on solid footing. Employment growth is getting better, consumer and business confidence is improving and lower energy prices are acting as a tailwind.
Diverging monetary policies have been pushing the value of the U.S. dollar higher. At this point, most observers assume the Fed will begin increasing rates next year as the economy continues to improve. Across the Atlantic, the ECB is still ramping up its easing policies and we anticipate that the Bank of Japan will engage in additional easing measures as well. These differing stances are a main reason the U.S. dollar has experienced notable appreciation over the last few months.
We believe U.S. Treasury yields will continue to rise over the coming months. The jump in yields last week was not an outlier. We have been forecasting that bond markets will catch up to the reality that U.S. economic growth is accelerating. At this point, we expect the yield on the 10-year Treasury to be at 3% or higher by the end of the year.
ECONOMY, BULL MARKET HAVE ROOM TO RUN
The current U.S. economic expansion and equity bull market have been underway for five years now, but we do not believe either is approaching an endpoint. Typically, economic expansions and bull markets come to an end when inflation pressures are building, which cause the Fed to begin tightening monetary policy in an effort to curb growth. We are expecting the central bank to begin gradually tightening next year, but this move would not come as a result of higher inflation, but rather as an acknowledgement of improved growth. By that basis, the expansion and bull run are far from the endgame.
(But some market watchers point out that many Nasdaq stocks are mired in a bear market.)
We do expect to see episodes of volatility and periodic equity market setbacks, but the underlying fundamental backdrop remains supportive of economic and earnings growth, which should lead to rising equity prices.
Since the current cycle began, U.S. growth has been better than that seen in other regions and U.S. stocks have outperformed other developed markets. We do not see that changing any time soon. For the last few years, investors who have been overweighting U.S. stocks have done well, and we believe this strategy continues to make sense going forward.
Robert C. Doll is chief equity strategist and senior portfolio manager at Nuveen Asset Management. This post first appeared here.
