Thoughts on the Federal Reserve Open Market Committee meeting and interest rates
- As expected, the FOMC raised the Fed Funds rate to a target range of 2.25% to 2.50%.
- The question for many is given markets had effectively “priced in” or were largely expecting the rate increase, why did equities sell off sharply and bonds rally strongly on yesterday’s Fed Funds news?
- We – and many market participants – expected the Fed’s post meeting statement and Chairman’s Powell press conference to strike a much more dovish tone over the outlook for interest rate policy into 2019. We think the Fed fell short on both fronts.
- The Fed now expects two (instead of three) rate increases next year and also lowered their estimate for GDP growth in 2019 and their estimate of the long-term neutral interest rate (the Fed Funds rate that neither hinders nor helps economic growth).
- However, we believe the Fed did not adequately recognize the impact recent market volatility, slowing economic growth outside the US and the ongoing US / China trade dust up is likely having on corporate sentiment and spending, and how a weakening of both could ultimately cause the US economy to stall and potentially slide into recession.
- We see two primary risks for the markets and the economy into the new year – 1) a monetary policy mistake (the Fed going too far, too fast) and 2) a trade policy mistake (the US / China trade dynamic worsening). After today, we have not yet “solved for” monetary policy risk, which means investors will likely be looking even more intently for good news on the trade front. We are optimistic that it is coming. In the meantime, the risk posed by monetary policy to the economy and markets has increased.
- Finally, the next Fed meeting isn’t until January. We expect investor disappointment over today’s FOMC statement and Chairman Powell’s press conference to be additive to already heightened market volatility. However, a bear market is not our base case. There is still time for monetary policy and trade policy to move in a more supportive direction for both the economy and risk assets as we enter 2019. Meanwhile, indicators of an imminent bear market or recession aren’t present, and we can continue to cite several positive economic and market data points, including…
- The yield curve has not inverted
- Inflation remains contained (including wage inflation)
- Corporations and consumers have ample access to credit
- US fiscal policy remains accommodative
- US corporate earnings should grow 20%+ this year and by mid to high single digits next year
- Market valuation is attractive with the S&P 500 trading at about 15x forward earnings