Fed’s Nod to Reality Considered Insufficient by Markets
Portfolio Manager Mayur Saigal explains why the Fed’s decision to make only modest revisions to its rate hike trajectory took markets by surprise on Wednesday.
- The Fed raised its benchmark rate by 0.25% on Wednesday, and left the door open for future interest rate hikes.
- Risks were asymmetric heading into the Fed meeting, given that markets were pricing in a “one and done” scenario.
- We give the Fed credit for replenishing its war chest when economic conditions allowed, but after nine hikes we believe that the Fed is near the peak of this tightening cycle.
The Federal Reserve (Fed) raised the overnight lending rate by 25 basis points (bps) on Wednesday, and slightly revised downward its projected interest rate path. Immediate market reactions suggest that this outcome and market expectations were not aligned. Markets were generally prepared for a “one and done” scenario, in which the Fed acknowledged challenges in the economic growth picture and indicated the necessity of a long-term pause in its rate hike trajectory. In our view, the risks were asymmetric heading into the day’s events.
Chairman Jerome Powell gave a nod to the slowdown in global growth, tightening financial conditions, heightened market volatility and a probable moderation in U.S. economic growth. However, he generally painted a positive picture of the U.S. economy, stating that the Fed’s outlook had not fundamentally changed. And while markets were preparing for no hikes in 2019 and potential cuts in 2020, the Fed opted to leave an opening for additional hikes, penciling in two for 2019.
Mr. Powell’s emphasis on the fact that any future moves would be highly data dependent did little to console markets. Stocks endured a strong swing, erasing pre-meeting gains. The Treasury yield curve flattened, with the front end held hostage by the possibility of additional rate hikes, and the 10- and 30-years rallying as investors expressed concern over the potential for policy error.
While we believe that the adjustment to the rate path reduces the chance of policy error accelerating an economic contraction, the risk of overtightening still remains – particularly given the slowdown in global growth, unresolved trade issues and the absence of accelerating inflation. In light of the risks to the economy, we believe that after nine hikes, the Fed is near the peak of this tightening cycle. To its credit, the Fed replenished its war chest and thus has room to react accordingly should recessionary concerns materialize. In this sense, it remains well head of its peer central banks.
Basis Point (bp) equals 1/100 of a percentage point. 1 bp = 0.01%, 100 bps = 1%.