Don't bank on a Fed put yet

Thought of the day

by Chief Investment Office 23 May 2019

The Federal Reserve doesn't look set to ride to the rescue of equity markets anytime soon, based on the minutes from its 30 April to 1 May meeting. Instead, monetary policy officials continue to favor a "patient" approach to policy.

The minutes underline that the Fed remains ready to respond to a marked deterioration in the growth and inflation outlook, but this doesn’t mean a rate cut is imminent:

  • The Fed meeting took place before the US announced its latest round of tariff increases against Chinese goods. We believe investors should now brace for a longer and bumpier path towards an eventual US-China trade deal, and the resulting uncertainty is likely to cause delays in corporate investment. But we still expect a deal to be reached eventually, and the Fed is not yet too concerned about tariffs. James Bullard, President of the St. Louis Federal Reserve, said this week that for tariffs to affect Fed policy, they would have to stay on for “quite a while, something like six months.”
  • Weak inflation data could give the Fed leeway to cut rates. Several Fed officials noted that if inflation does not show signs of moving higher over the coming quarters, there is "a risk that inflation expectations could become anchored at levels below those consistent with the Committee's symmetric 2 percent objective." In other words, too-low inflation is seen as a potential problem if it persists, but the possibility of a quick rate cut wasn’t discussed.
  • Fed officials did discuss the potential for a return to bond purchases in the event of a major economic setback. But the FOMC "continued to view" economic activity as robust. The Committee noted that it had marked up its forecast for real GDP growth. They do expect some slowing after the first quarter, but are bullish on the outlook.

Our base case is that the Fed looks unlikely to move rates in either direction through the end of 2020, with US growth remaining around trend. It now looks more likely that inflation stays muted, central banks accommodative, and world economic growth near or below trend. We think this is a more favorable environment for yield strategies. In our recent note “Be prepared: Plan, Protect, and Grow,” we discussed a number of ways to find yield, including investing in dividend-paying stocks and multilateral development bank bonds.

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