Fed Leaves Market with Cliffhanger
The Federal Reserve lowered its benchmark rate at its September meeting, but is divided about whether further cuts will be needed this year. Co-Head of Global Bonds Nick Maroutsos says the stance creates uncertainty for investors and ignores structural challenges in the global economy.
- As expected, the Federal Reserve cut its benchmark rate a quarter percentage point at its September meeting.
- However, even as market participants are forecasting one more cut in 2019, less than half of Federal Open Market Committee members believe further reductions are necessary.
- This divisiveness creates uncertainty for markets and could lead to further volatility, especially as structural headwinds such as negative bond yields put pressure on the 10-year Treasury.
As expected, the Federal Reserve (Fed) lowered its benchmark rate today a quarter percentage point. It was the second consecutive time the central bank cut rates, and it brings the federal funds rate to a range of 1.75% to 2.0%.
The move comes as the Federal Reserve Bank of New York had to inject liquidity into markets on Tuesday and Wednesday to meet short-term funding needs at banks and keep the federal funds rate within its targeted range.
During the Fed’s press conference, Chairman Jerome Powell said the central bank lowered rates to help keep the U.S. economy strong in light of global uncertainties, and highlighted that business investment and exports had weakened while inflation remained muted. But less than half of the 17 members of the Federal Open Market Committee expect another rate cut by the end of 2019.
Fed Divided on Economic Data
Even as risks stack up in the global economy – from the looming Brexit deadline to ongoing trade tensions – Mr. Powell noted that the labor market remains strong, consumer spending has been rising and the U.S. economy continues to expand. Given the mix of economic data, Mr. Powell said the current environment was creating a time of “difficult judgments and disparate perspectives.”
The Fed’s reluctance to provide a clear signal about its next move was initially received negatively by markets, with U.S. equities and Treasuries selling off immediately following the central bank’s announcement.
Fed Falls Short of Market Expectations, Needed Change
Market participants overwhelmingly expect further easing by year-end, as measured by federal funds futures. In addition, last week the European Central Bank (ECB) took aggressive steps to ease financial conditions in the eurozone. We believe the ECB effectively put the Fed on notice not to repeat the mistake of July and deliver a message that could be construed as hawkish.
But the Fed disappointed on both counts. What’s more, we think structural issues in the global economy could force the Fed’s hand. Tepid economic growth, persistently low inflation rates, excess debt levels and negative yields are all combining to weigh on long-term rates. Already, the 10-year Treasury has fallen to as low as 1.47% this month. Though rates have backed up, we believe the 10-year could drop to as low as 1.0% over the next nine months.
The Fed did lower the rate of interest it pays on reserves to try to prevent another liquidity shortage and directed the New York Fed to take action to keep short-term lending rates below the Fed’s target rate. We believe a more permanent solution is called for, including restarting the central bank’s bond buying program, which would more effectively increase cash reserves. We live in a world where liquidity is at a premium and any scarcity of that liquidity could severely impact and elevate volatility across all asset classes, as short-term funding is the backbone to debt markets.
In our view, the Fed has left markets with an unwelcome cliffhanger. Investors, we think, should expect more volatility.