Fed Holds Steady Against Market Pressure

The Federal Open Market Committee (FOMC) held rates steady today, leaving the fed funds rate at 2.25% - 2.50%, but left the door open for possible rate cuts later this year. In acknowledging that economic growth is slowing, the Fed dropped the word “patient” from its statement and instead indicated that it would “act as appropriate to sustain the expansion.” James Bullard was the only dissenter who voted in favor of an immediate rate cut, the first to dissent since Jerome Powell became Chairman. A total of eight officials support a cut by the end of the year.

Since the start of the year, the Treasury market has rallied significantly in anticipation of a more dovish Fed (see chart below), with some market participants even expecting a 25-basis point cut today. The Fed did not see enough economic deterioration to warrant an immediate rate cut, but in the accompanying statement did acknowledge that “uncertainties about this outlook have increased.’’

Year-to-date Market Action

Language Changes and Themes

  • The FOMC downgraded economic activity to a “moderate” rate from “solid.”
  • “In light of these uncertainties and muted inflation pressures, the Committee will closely monitor the implications of incoming information for the economic outlook and will act as appropriate to sustain the expansion.”
  • The FOMC “indicators of business fixed investments have been soft,” which is a nod to trade tensions.
  • "In light of these uncertainties and muted inflation pressures, the Committee will closely monitor the implications of incoming economic information...and will act as appropriate to sustain the expansion..."

Conclusion

The Fed’s monetary policy will continue to be data dependent with risks tipping to the downside. While the bias may now be to the downside, the amount and timing of any easing (beyond stopping the balance sheet reduction) will be based on data. Should there be a recovery in sentiment, growth, and inflation, monetary policy may be on hold for an extended period. The Fed is now positioned to cut rates on further deterioration of growth or inflation.

Recent data show that growth momentum is slowing while PCE inflation remains stubbornly below the Fed’s 2% target.

Fundamentals:

  • The U.S. economy is slowing from the elevated tax stimulus levels back toward trend/potential GDP
  • Corporate America remains cautiously optimistic, but trade tensions introduce uncertainty while tariffs reduce growth
  • American consumer remains in decent financial shape
  • Fiscal policy options are limited due to ballooning deficit
  • Global growth continues to weaken
  • Unemployment rate remains historically low

Technical forces, as listed below, continue to be very influential on the rate markets.

  • $12 trillion in negative yields globally have pushed investors to the US markets
  • Political influence: trade policy uncertainties
  • Global central banks remain accommodative
  • Fed will end balance sheet unwind in September 2019
  • Global conflict/tensions on the rise

Complicating the Fed’s course of action is the protracted uncertainty surrounding the trade war with China, as well as unprecedented political pressure from the White House. Were there to be a near-term resolution to the tariff uncertainty, possibly at the upcoming G20 meeting, we would expect the economy to remain at trend growth and the Fed to disappoint market expectations with less monetary stimulus.

If you have questions on the market impact as these events unfold, please reach out directly.

Disclosure
The opinions contained herein are those of Longfellow Investment Management Co., LLC (LIM) at time of publication and may vary as market conditions change. They are based on information obtained by LIM from sources deemed to be accurate and reliable. However, accuracy is not guaranteed. It is in the sole discretion of the reader whether to rely upon the opinions contained herein. The information provided does not constitute investment advice, is not a recommendation, offer or solicitation to buy or sell any securities, or to adopt any investment strategy and should not be relied upon as such. It does not take into account an individual investor’s particular investment objectives, strategies, tax status or investment horizon. There is no guarantee that any forecasts contained herein will come to pass. Past performance is not an indication of future results. Investment involves the possible loss of principal.