Additional Market Commentary
Fed cuts interest rates second meeting in a row, committee divided on need for further easing
The U.S. Federal Reserve (Fed) reduced its target policy rate (“fed funds rate”) range by 0.25 percent today following its scheduled two-day meeting. The move was widely expected, as interest rate markets had priced in the cut with virtual certainty. Fed Chairman Jerome Powell echoed prior comments the committee remains prepared to “act as appropriate to sustain the expansion” but was hesitant to commit to further policy actions without additional information. The committee is divided on whether further interest rate cuts are necessary based on their estimates of future policy rates. Market expectations were trimmed though still indicate high odds of one more 0.25 percent cut this year (for a total of three) and one to two cuts next year, setting the stage for volatility around Fed announcements in the fourth quarter. Stocks were mixed and bond yields rose on lower odds of additional policy accommodation.
Investors were focused on Chairman Powell’s press conference and other supplementary data. Chairman Powell stated the U.S. labor market and domestic economy continue to perform well, but business investment and exports have weakened amid falling manufacturing output due to slowing growth abroad and trade developments. The summary of economic projections, which aggregates individual Fed participants’ forward views, indicates growth and unemployment rate projections ticking slightly lower for 2019, and a small reduction in growth estimates for 2021. Chairman Powell downplayed recent pressures in short-term cash lending markets’ significance, though technical changes to policy implementation were made.
The Fed’s “dot plot,” which shows FOMC members’ forecast for year-end policy rates, indicates the median expectation is for steady rates for the remainder of 2019 and 2020, before rates rise in 2021. This is in stark contrast to market expectations which price in an additional rate cut in 2019 and one to two cuts in 2020. Member expectations vary a great deal, with some expecting higher rates and some lower by year end, with similar dispersion in 2020. Two voting members favored keeping the policy rate unchanged today, while one favored a larger 0.50 percent reduction. Powell’s leadership will be tested as he attempts to gain greater consensus among the committee in coming months; he will be challenged to balance differing views on the committee when weighing trailing data that remains reasonably strong versus managing risks on the horizon.
Fed communication remains disconnected from markets, though the gap has eased in recent weeks and again today. Investor sentiment remains relatively strong, indicating that investors are maintaining high expectations for multiple rate cuts to prevent significant economic weakening in the U.S. This creates a potentially volatile market environment if the Fed does not deliver interest rate cuts in line with market expectations or if we experience significant economic outlook deterioration.
We remain focused on the trend in domestic and international economic data. We track hundreds of economic data points across the globe via our proprietary “Health Check” monitor, which indicates the global economy is on a path of a re-synchronized slowdown. The rest of the world is slowing and the U.S. economy, which had been outperforming, has consolidated with the rest of the world. However, odds of a recession, while rising, remain modest globally and subdued for the United States. The Fed is likely to remain on an easing trajectory (though perhaps not to the extent markets would prefer) and other global central banks are cutting interest rates at the fastest pace since the financial crisis.
We maintain our balanced assessment of risks between stocks and bonds, which is guiding our recommendation to hold stock and bond allocations close to long-term strategic target allocations. This reflects higher levels of volatility across global equity markets and lower bond yields in the United States relative to year-ago levels. We recommend high-quality bonds comprise the majority of bond portfolios to provide adequate portfolio diversification against riskier holdings.
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