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The Federal Reserve: Give the People What They Want


The FOMC (Federal Open Market Committee) meeting was highly anticipated but only in the sense that many were looking for confirmation on the degree of dovishness that matched the market’s belief. It has shifted from not being restrictive to stepping toward more accommodative. We discussed this in January and what it may mean for the markets: https://www.aamlive.com/blog/201901/federal-reserve-vows-patience-in-monetary-policy. The Fed gave exactly what the dovish camp was asking for. Here are some highlights:



  • The Fed sees no 2019 rate hikes, which as we show below confirmed the markets expectations and was voted on unanimously. 

  • They have lowered growth projections for 2019 to an estimated 2.10% annual growth rate. 

  • They also see that asset drawdown will end in September of this year while slowing the shrinking by the end of May.

  • In October they announced they will be using maturing mortgage back proceeds into Treasuries.

  • As a byproduct, there was a substantial rally in interest rates with more subtle rallies in equities.


What we saw leading up to the meeting and the market’s reaction was an about face from the historic selloff in December. Consider that on December 3, 2018, the Fed fund futures were pricing in a 95% chance of a rate hike in the next 12 months. As evidenced by the table from Bloomberg below, the market expected two rate hikes, including a 90% chance of a rate hike in March, and a 0% chance of a rate cut (denoted in red).



Source: Bloomberg


Fast forward a little over three months and as the FOMC meets today, my how things have changed. Prior to today’s meeting there was a 0.5% chance of a rate hike in the next 12 months and 36% chance of a rate cut. 



Source: Bloomberg


After the meeting today, the Fed fund futures now points to a 49.2% chance of a rate cut in the next 12 months with a 11% chance of two cuts. 


For comparison purposes, consider the current benchmarks for European rates are -0.40% and Japan is -0.10%. In Europe they are expecting a rate hike, only because the negative rate is already absurd. However, in Japan, there is a 31% chance of further rate cuts from the already negative base rate. It is astonishing how the markets and “reasonable” policymakers have become acclimated to the purely unnatural state of negative rates.


While many may think the market panic was the primary cause for the shift, the primary about face was driven by a tightening in the financial conditions index and tightening in loan requirements from the Federal Senior Loan Officer survey.



  • The St. Louis Federal Reserve Bank Financial Conditions index spiked to its highest level in two years in December, not seen since the stealth bear market of 2015. This was confirmed by the magnitude in the tightening of the Goldman Sachs Financial Conditions index.



  • There was a reaction by the senior loan officers stating that they were raising standards for loans back to the more restrictive 2016 levels. Hence, you began to see more reports about stress testing in the financials arena and focus on liquidity in the banking system.


When we fast forward to today’s meeting, a couple of macro aspects should be front and center. Global central banks have maintained their accommodative mode as global growth decelerated in 2017.


The Federal Reserve has had 12 speeches in which the topic of inflation was minimized as a current problem. With the correction in the energy markets and robust rebound, look for these inflationary metrics to be volatile and show some lower rather than higher prints. The key will be if the energy markets continue to rebound as we think they will. One other anecdotal component that we are keenly interested in is the narratives that have come from the academic portions of the Federal Reserve in which they state that had they embarked on negative interest rates, the recovery from the Great Recession would have been quicker and more profound. Simply putting this out there allows the fences that once constrained monetary policy to now be extended. This is an immensely important psychological aspect that allows the Fed to propel they have more tools than they once had in the hopes it amplifies the effectiveness of their actions.


On a global scale, we have thoroughly discussed the lengths the People’s Bank of China (PBOC) has gone through to stimulate their economy while trade negotiations have been moving through. It is not just monetarily as they are also emphasizing liquidity and consumption. The Bank of Japan (BOJ) has continued its QE (quantitative easing) infinity and we don’t see that reversing course anytime soon. Recently, the European Central Bank (ECB) has stated through recent announcements from ECB President Draghi its intentions to be more accommodative. In all, the four central banks (United States, Europe, Japan and China) have $19.7 trillion in assets.


While we received what we expected in the Federal Reserve’s announcement today, there is a reason to be concerned about the specter of inflation even while they believe it is not a threat at the current time. While many think this is subdued, we have seen some wage inflation in the future based on trends in the unemployment trend. In late stage cycles with a tight labor market, technology investments to offset the pressure from rising wages has a lead time that creates a stressful decision for companies. The desire for an offsetting labor pressure with technology relief is not as instantaneous as they prefer.


The pause by the Federal Reserve is akin to the ounce of medicine versus the pound of cure, but like we have all learned by every decision, there are side effects. We must be cognizant of the intended and unintended consequences that any abrupt shift could bring. The announcement by the Fed helps propel the growth rate – albeit anemic – that the last 10 years has brought us. 


 


CRN: 2019-0320-7319R


This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the Disclosures webpage for additional risk information at commentary-disclosures. For additional commentary or financial resources, please visit www.aamlive.com.

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