This browser is not currently supported. Please upgrade to a newer version of Google Chrome, Mozilla Firefox, or Internet Explorer 9 through 11 for the best experience.
News, research and market insights from our team of experts.
Following a turbulent close to 2018, financial markets rebounded nicely in early 2019. The primary reason behind the reprieve in market volatility was the messaging by the Federal Reserve, which suggested the Federal Open Market Committee (FOMC) may hold off on further rate hikes for the time being and consider a slower pace of quantitative tightening. Thawing trade tensions with China and an end to the government shutdown also helped support asset prices.
It’s important to note, the Fed has been tightening monetary conditions for three years – since the FOMC first raised the fed funds rate in December 2015. The objective of tightening monetary policy, of course, has been to keep the economy from overheating. As economic growth reached full capacity and unemployment dropped to the lowest levels in nearly 40 years, it was quite reasonable for the Fed to take away some of the extraordinary stimulus which had been in place since the Great Recession. But in January we learned Fed officials are comfortable with current interest rate levels and the December 2018 hike may have been the last one for now.
Several factors may have contributed toward the change of direction by the Fed. Elevated volatility in financial markets and the slowdown in interest rate-sensitive sectors such as housing and autos suggested Fed rate hikes were beginning to take a bite. Rather than risking an excessive slowdown (e.g. a recession), Fed officials opted for a wait-and-see strategy. In other words, policy will change in either direction only as economic data deviates significantly from current levels.
Given this pause, the risk of a Fed-induced recession has diminished and investors can focus attention on economic and corporate fundamentals. On that front, the picture is mixed. Recent volatility has put a dent in consumer and corporate confidence indices. As stated earlier, interest rate-sensitive sectors of the economy have slowed in recent months. However, it’s too soon to call for a recession despite softer data.
This chart illustrates the fed funds rate alongside personal consumption expenditures (PCE), a measure of consumer inflation. Overall inflation expectations are well anchored around the Fed’s target levels although the recent employment report shows continued strength in labor markets. Despite recent healthy wage gains, labor costs don’t yet pose a major risk to corporate profits. Also, stable oil prices at lower levels will be supportive of consumer expenditures and capital investment.
The corporate sector remains resilient even after a record economic expansion. Although corporate confidence surveys weakened in recent months, they should stabilize now that the Fed has taken its foot off the brakes. A stable Fed policy should provide visibility for capital expenditures.
The big question, as has been the case lately, is whether political wrangling in Washington and abroad will remain contained. Negotiations around border security in the U.S. continue to pose headline risk and Brexit negotiations are running out of time. Also, trade tensions continue to erode confidence at home and abroad. Strong exporting countries such as China and Germany have seen slower economic activity and their officials have been unable to stem the tide.
Many of these issues are inherently unpredictable and should not alter the positioning in a long-term investment plan. Volatility in recent weeks reminds investors of the influence the Federal Reserve exerts on the markets. Despite the respite from Fed Funds rate hikes, volatility may continue as economic data alters the balance of risks.
The above commentary represents the opinions of the author as of 2.20.19 and are subject to change at any time due to market or economic conditions or other factors. The information above is for educational and illustrative purposes only and does not constitute investment, tax or legal advice.Print