Despite strong economic growth since the start of the year, the Federal Open Market Committee is exp...
Despite strong economic growth since the start of the year, the Federal Open Market Committee is expecting growth to moderate to a more sustainable pace, partly reflecting a gradual cooling of the housing market and the lagged effects of increases in interest rates and energy prices.
This was one of the reasons it opted to increase interest rates by a further 25 basis points to 5% at its meeting on 10 May.
It says the increase in prices of energy and other commodities appears to have had only a modest effect on core inflation, while ongoing productivity gains have helped to hold the growth of unit labour costs in check, leaving inflation expectations contained.
The Committee predicts further policy firming could be needed to address inflation risks but emphasises the extent and timing of any such firming will depend on the evolution of the economic outlook as implied by incoming information.
Cormac Weldon, head of US equities at Threadneedle Investments and manager of the Threadneedle American Select fund, comments: "As expected, the Federal Reserve raised interest rates. However, while it observed that some further rate increases might be necessary, it appears they have signaled the long-awaited pause in the interest rate increases that started in June 2004 if inflation remains in check.
"We expect the Federal Reserve to take note of economic data over the next few months, looking for signs of inflation before deciding to take any further interest rate action."
"Threadneedle's expectation is that economic growth will remain above 3% while inflation will remain contained, allowing the Fed to leave interest rates on hold for the rest of this year. This is a positive backdrop to the US equity market where earnings are expected to grow."
It is this outlook that has led Peter Kaye, fund manager of the Melchior North American Opportunities fund (MNAOF) to remain bullish on US equities. According to Kaye, the US market offers very attractive value and is poised for a year of strong performance.
He explains: "There would appear to be a disconnect between fundamentals, which remain excellent, and an equity market that has failed to make much headway for two years. Corporate America is in fabulous shape after three years of robust double digit earnings growth. Cashflow is at record highs and balance sheets have never been stronger.
"The result of this disconnect is a market trading on a 10-year low in terms of forward price earnings multiple. The apparent major factor in this disconnect is the risk of inflation and therefore the duration of the current interest rate cycle.
"However, core inflation data has been subdued, long-dated bond yields remain low and there is little evidence of significant pricing power at the corporate level. After 15 tightening moves in US interest rates, all indicators point to an end in the rate cycle in coming months."
Rupert Della Porta, head of US Large Caps at F&C Asset Management and manager of the F&C North American fund, agrees and points out that at 11,639.77 points (May), the Dow Jones was within 0.7% of a new all-time high. The last high was on 19 January 2000 when it reached 11,722.98.
He adds: "The most famous measure of stock markets in the US, the Dow Jones, is poised to surpass the prior 'new economy' fuelled peak in 2000. Crossing 11,723 would mark a remarkable comeback for an index down 38% in early 2003 from its peak.
"Led by beneficiaries of the global trend to low cost airlines and the China-led construction boom, Boeing and construction equipment manufacturer Caterpillar top the winners of the Dow since the previous peak. Energy giant Exxon is up there too, as are some of the successful restructurings of recent years - McDonald's the burger giant, Hewlett-Packard, the once struggling computer company, and Altria, the food and tobacco company that was once going to be put out of business by civil litigation."
Fed raises interest rates to 5%
Economic growth likely to moderate in coming months
Outlook for equities remains positive
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