In this piece, we highlight:
- The Fed, which has now more than done its job in helping to clear a path for equity and credit investors in the year ahead
- Two rate cuts that are now in the books in 2019, and a third that remains on the table between now and year end
- Fed Chairman Jerome Powell and members of the Federal Open Market Committee (FOMC), who may not be in perfect alignment; however they appear flexible and rationale enough to navigate the months ahead
- A possible resolution to the U.S.-China trade hostilities and their associated tariffs, which continues, in our opinion, to be the biggest wild card facing investors
As expected, the Federal Reserve concluded its September meeting by reducing the Fed Funds rate by .25% to a range of 1.75%–2.00%. As was the case following recent Fed meetings, the market then went on an immediate search for drama and game-changing-type perspectives, but for the most part could not find any. After initial concerns that Chairman Powell might have a less-than-stellar, post-meeting news conference (as has been the case in the past), the Dow Jones Industrial Average initially sold off more than 200 points before ultimately finishing in positive territory for the day.
As for the news conference itself, Chairman Powell‘s message was one of wait and see on further rate cuts, but with enough sidebar comments and caveats to assure the market the Fed would be ready to act if necessary. So while the drama may not have been there, the news conference was a dramatic improvement from ones previous.
In our Mid-Year Market Outlook, Clearing the Path, published in early July, we expressed that the Fed was on the verge of a mini-easing cycle that would likely result in .50%–.75% of rate cuts by year end. We have now seen .50% play out, and based on post-meeting market expectations, we believe there is a 50-50 chance of one more cut of .25% between now and year end.
In happily accepting the dearth of drama we would like to see continue at future Fed Meetings, here are highlights and perspectives we believe to be important for investors:
The Fed appears to be somewhat divided. The vote on the .25% reduction was 7-3, with two committee members dissenting based on their view that no rate cut was necessary and one believing a larger downward adjustment of .50% was warranted. This represents a wider range of thought than any we have seen in recent years at the Fed. However it just might also reflect a range of diverse perspectives necessary to negotiate the months ahead, which, based on this year’s developments, will likely be far from predictable.
Further rate cuts look to be highly data dependent. With two rate cuts now in the books, Chairman Powell seemed less rigid than he has in the past. He appeared to take on an air of flexibility in his approach and stressed that future rate reductions will be dependent on data, events, and risks between now and the next two meetings in October and December. In our opinion, a rate cut in October is unlikely and one in December is a jump ball at this point.
Inverted yield curve prompted an interesting response. When asked about the recent inversion in the Treasury yield curve and its message about pending recession risk, Chairman Powell seemed to be on a similar page to what we have expressed in previous commentaries this year. This is that while the inverted curve (short-term rates higher than long term) should be closely monitored and respected for its past history, there could well be reasons it is inverted other than forecasting a recession. We would agree with his assessment here.
Welcome comments about the prospect of negative interest rates. As the counterintuitive world of negative interest rates seems to be engulfing entire regions across the globe and now totals more than $17 trillion of sovereign debt, recent speculation has been growing as to whether the U.S. might ultimately fall victim to this mindset in years ahead. In addressing this topic, Chairman Powell pretty much shut it down conceptually — “I do not think we’d be looking at negative rates” — and stressed that if ever back in a zero-rate environment, the Fed would reapply quantitative easing and asset purchases rather than negative rates. This dose of logic and rationality was also appreciated by the market, as bank stocks rallied following these comments.
Tariffs and trade loomed ever present throughout the news conference. Chairman Powell also commented on the U.S.-imposed tariffs and ongoing trade hostilities with China, not from a policy implementation standpoint but pertaining to the potential risk to the economy that needs to be taken into account. Our perspective is that the U.S.-China trade dispute remains the biggest wild card facing the markets. Should we see a reconciliation eliminating or materially mitigating currently imposed tariffs in the months ahead, it would alleviate perhaps the final obstacle standing between investors and a strong year for the equity and credit markets in 2020. Should we not see a resolution by December, or at least a clear path to one, we believe an additional rate cut at that time will become more likely.
In conclusion, we believe with this September rate cut the Fed has done its job in helping to clear a path for investors in the year ahead. The “Goldilocks” scenario of mid-2% economic growth, benign inflation, lower interest rates, double-digit corporate earnings growth, and reasonable stock valuations remain very much on the table. In addition, the Fed has now officially canceled out two of last year’s four rate hikes with potentially a third to follow. All of this bodes well in our opinion for a good-looking environment for stock and credit markets in 2020. If there is a trade resolution with China between now and year end, it may look even better.
All of which we will gladly take over a drama-filled day at the Fed any time.
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