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Davis: Current Environment Doesn't Encourage Risk-Taking

Investors would be wise to stick with their long-term plan, as risk-taking will likely not be rewarded in the current market climate, says Vanguard's Joe Davis.

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser, here at the Morningstar ETF Conference. I'm joined by Joe Davis--he's Vanguard's global chief economist. Joe, thanks for joining me.

Joe Davis: Thanks. Pleasure to be here, Jeremy.

Glaser: It's nice to speak to you now; last time we spoke, the Dow was down a thousand points. It's a little bit calmer now. But a lot of those worries are still out in the market--and particularly now that the Fed has said that they're not raising rates because they're worried about some of these global issues. Do you think the Fed is going to raise rates anytime soon? Is December still a real possibility?

Davis: I think so, Jeremy. We went into the year saying two things. One is that the labor market is a little bit tighter than perhaps the Fed thinks, in part because Americans may not return to the labor force as quickly as the Fed had anticipated. The other is that U.S. growth was going to hold up in an otherwise frustratingly fragile world. And when you put those two together, you come to the conclusion that the Fed is still likely to raise rates, but that path is very moderate. We have not changed our view that, over the next several years, the Fed will be hard-pressed to raise rates above, say, 1%. So, again, it's removing some of the exigent circumstances that the Fed exercised in 2009, dropping below 1%, and hence [quantitative easing]. I'd characterize it more as a path of a dovish tightening rather than as just a march toward 2%, 3%, or 4%.

Glaser: How about inflation? It's still running low. The PCE numbers this week were still low. Do you think Yellen is right that we are going to get back, in the medium term, to the 2% level?

Davis: I think so. I think it's understandable for the Federal Reserve or for any economist or central bank to be reasonably confident the Fed is going to achieve 2%. They're waiting to see more stabilization rather than rebounds in the commodity markets and the U.S. dollar--there's a limit to how much further they can fall. That said, core inflation has been roughly below 2% for half of the past 20 years. In our minds, there's still a deflationary bias in the world globally, given what we continue to see both out of China and the emerging markets. So, I think, ultimately, core inflation should converge to that 2% level, but it could take up to 2018 before that's ultimately realized. Now, the Fed is trying to anticipate that and, again, trying to remove some of that excessive accommodation that they've had.