May 01, 2019
As expected, the Federal Reserve (Fed) kept the target policy rate range unchanged following its two-day meeting. The overall message of patience was consistent with previous communications. The statement noted that inflation continues to run below the Fed’s 2 percent target. However, during the post-meeting press conference, Fed Chairman Powell emphasized that the recent weakness may be transitory, which suggests the Committee sees little need for an interest rate cut at this time.
While there was a small adjustment made to the rate banks receive for excess reserves (known as the IOER), we view this as a small adjustment to the “plumbing” of monetary policy rather than indicative of any change in overall policy outlook. There were no updates to the Fed’s economic projections or median rate expectations at this meeting. As the odds of a rate cut later this year fell, bond yields rose while the S&P 500 closed near the lows of the day. Riskier corporate bonds and other interest-rate sensitive assets (such as real estate securities) also fell modestly. After Powell emphasized the belief in the transitory suppression of inflation, the U.S. dollar rose, which pressured non-U.S. asset prices, such as foreign developed and emerging market equities.
The Fed statement characterized economic growth as “solid” while noting consumer spending and business investment has slowed. The Committee also cited core inflation as slowing and running below 2 percent. During the press conference, in our view, Powell made three important points. First, he stated the Committee would need to see persistently low inflation to consider cutting interest rates, and that recent weakness in core inflation may be transitory. Second, he noted “we don’t see a case for moving [policy rates] in either direction.” Third, Powell said, “recent data suggests [household consumption and business investment] will bounce back, supporting our expectation of healthy gross domestic product (GDP) growth over the rest of the year.”
While we continue to expect no changes to the Fed’s policy rate this year, there is a distinct two-sided risk. The labor market remains quite strong (as seen in today’s private payroll survey) while economic data remains stable enough to justify a rate hike late in 2019 or early 2020. However, if inflation remains muted or weakens further, it could prompt the Fed to cut rates despite market expectations that any drop in inflation would be temporary. Currently, the market is pricing in meaningful odds of a 0.25 percent cut by year-end and another in 2020.
We remain focused on the trend in economic data in the United States and globally. Our analysis indicates the global economy is on a path of a re-synchronized slowdown. Odds of a recession remain modest globally and low for the United States. We are maintaining 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 higher policy rates in the United States relative to year-ago levels. Within bond portfolios, we favor below-benchmark maturity profiles to reduce price risk in the event of rising bond yields, and as a reflection of the limited incremental return for extending maturities. We advise that bond portfolios be primarily comprised of high quality bonds to provide adequate portfolio diversification, which is supported by somewhat elevated valuations in riskier credit categories such as high yield corporate bonds.
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Based on our strategic approach to creating diversified portfolios, guidelines are in place concerning the construction of portfolios and how investments should be allocated to specific asset classes based on client goals, objectives and tolerance for risk. Not all recommended asset classes will be suitable for every portfolio. Diversification and asset allocation do not guarantee returns or protect against losses.
Equity securities are subject to stock market fluctuations that occur in response to economic and business developments. International investing involves special risks, including foreign taxation, currency risks, risks associated with possible differences in financial standards and other risks associated with future political and economic developments. Investing in emerging markets may involve greater risks than investing in more developed countries. In addition, concentration of investments in a single region may result in greater volatility. Investments in fixed income securities are subject to various risks, including changes in interest rates, credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications and other factors. Investment in fixed income securities typically decrease in value when interest rates rise. This risk is usually greater for longer-term securities. Investments in lower-rated and non-rated securities present a greater risk of loss to principal and interest than higher-rated securities Investments in high yield bonds offer the potential for high current income and attractive total return but involve certain risks. Changes in economic conditions or other circumstances may adversely affect a bond issuer's ability to make principal and interest payments. Investments in real estate securities can be subject to fluctuations in the value of the underlying properties, the effect of economic conditions on real estate values, changes in interest rates and risks related to renting properties (such as rental defaults).
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