By Tony Soslow, Clark Capital

With my youngest now 19 and off to college in the fall, I begin to consider my parenting obligations as both boys are now technically adults and on their own. Do my wife and I now “stand back and just let go,” claiming “mission accomplished” or do we need to continue our mild helicoptering, advice offering and nudging?

Albeit on a much different scale, the Fed is also confronted with their own Dilemma of Success as recently released data show the May PCED year-over-year core inflation rate finally hit 2.0% — matching their official target established in a statement on January 12, 2012. Combine that with the current unemployment rate being below what is considered full employment and Fed officials have reached all objectives and are thus facing a similar conundrum. What to do now?

Is Micromanaging Helicoptering?

Certainly, robust U.S. economic strength and rising levels of wage growth provide support for the Fed’s continued scheme of monetary policy normalization (I call it tightening) through the end of next year.

Global economic activity as measured by the broad-based Purchasing Manager’s Index (PMI) accelerated in June, nearly matching February’s three-and-a-half year high. Growth was noticeably stronger in developed markets as the U.S. PMI hit 56.2 or just shy of May’s three-and-a-half year high and Europe’s index at 54.9 also predicts strong GDP gains.

Tightening labor markets corroborate the PMI statistics and the Fed’s agenda as sustained 2.7% average hourly earnings gains have enticed 600,000 workers to return to the work force. This has driven the prime-age employment/population ratio higher to 79.3%, matching the cycle high hit in February.

While current conditions depict near economic perfection, the Fed policy dot plot of likely future short-term interest rates implies that the yield spread between 10-year and 2-year U.S. Treasury rates (currently at just 0.30%) could turn negative by year end.

Historically, negative yield spreads correspond to investor expectations for slower economic growth and often precede recessions. As the Fed seems resolute in maintaining their current monetary micromanagement, little weight appears to have been given to “just letting go.”

Celebrating Small Failures

Optimum levels of current inflation and high levels of expected economic growth face headwinds from a nearly negative yield curve following seven interest rate increases since 2015. Free market economists may argue that the planned four additional rate hikes, which will drive the fed funds rate to 2.75 to 3.00%, are unnecessary. I am not sure if trade wars, labor market tightness, increasing energy or freight costs or a combination of these will slow economic growth. However, I am concerned that if the Fed maintains its current path, monetary policy will hasten a recession, causing undue harm or a hard landing.

The recent contraction in the yield spread implies that policy is already dampening investor expectations. Given the low yield spread and the balance of positive and negative influences on future growth, in our view abandoning the current interest rate tightening regime would be likely to lengthen the recovery and allow the economy to naturally descend into a soft landing. Instead of helicoptering around each cycle — transitioning from easing to tightening to easing again — this is a perfect time for the Fed to allow weaker parts to naturally fail and allow creative destruction to build more sustainable players for the future.

This article was written by Tony Soslow, CFA, a senior portfolio manager with Clark Capital Management Group, a participant in the ETF Strategist Channel.

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