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. Economist surveys and interest rate market prices anticipated the change. Both Fed Chairman Jerome Powell’s press conference and the official statement implied (and we expect) the Fed will hold rates steady in December while retaining the option to cut rates further if conditions deteriorate. Their preference is likely to await confirmation that this and two earlier interest rate cuts starting in July are enough to halt slowing economic trends. Market expectations for future cuts have fallen and imply another 0.25 percent cut by the end of 2020 as opposed to recent expectations for multiple cuts. This structure equates to high odds of no further cuts and low odds of multiple additional cuts in the event of further economic weakness. Stocks gained slightly on Chairman Powell’s comment that inflation would need to rise significantly before the Fed considers raising rates to address inflation concerns. Short-term bond yields, which move inversely with prices, fell slightly.
Investors focused on the formal statement and Chairman Powell’s press conference as the Fed provided no updates to economic projections, and bond markets had already priced in today’s cut. Both the statement and press conference implied holding rates steady is the likeliest path forward for now. Powell stated, “We see the current stance of monetary policy as likely to remain appropriate.” The official statement replaced the phrase “the committee…will act as appropriate to sustain the expansion” with the more benign phrase, “the committee…will assess the appropriate path of…rate[s].” Two members voted against the rate cut, reminding investors the Fed remains divided on the appropriate balance between insurance against future uncertainty versus monitoring trailing data. Market expectations now more closely align with Fed signals, removing a potential catalyst for market volatility in coming weeks.
Several factors have contributed to a disruption in short-term borrowing rates between institutions beginning in September. The Fed initially responded with overnight and two-week loan programs, then began buying Treasury bills to inject cash into markets in October. Chairman Powell has continued to downplay the Fed’s Treasury bill purchases as a technical change rather than monetary stimulus. We reaffirm our belief that the liquidity shortage does not foretell more substantive issues.
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. We also see signs that momentum could be bottoming, indicating the worst of the slowdown may be over. Central banks outside the U.S. are beginning to slow their pace of interest rate cuts after slashing rates at the fastest pace since the financial crisis during the third quarter.
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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