Fed holds rates, signals no 2020 cuts

Thought of the day

by Chief Investment Office 12 Dec 2019

In its first unanimous vote since May, the Federal Reserve decided to leave its interest rate target range unchanged at 1.5%–1.75%. The Federal Open Market Committee (FOMC) statement, Summary of Economic Projections (SEP), and Fed Chair Jay Powell's news conference all indicate that the Fed expects to remain on hold for a considerable length of time.

  • The Fed expects inflation to be near its 2% target, growth to be close to trend, and unemployment to remain low, giving members little incentive to move rates in either direction.
  • The dot plot shows not even a single participant looking for a rate cut over the forecast horizon. As Powell noted in his news conference, eventually rates should rise toward their long-run level of 2.5%.
  • Relative to the September SEP, the median dots have come down by 25 basis points, suggesting no rate hikes until 2021.

On the other hand, recent history has demonstrated that the Fed is willing to change its plan in reaction to an evolving economy. As noted in the FOMC statement, "the Committee will assess realized and expected economic conditions" and respond as appropriate.

In our view, the Fed will likely stay on hold. Inflation will need to rise above its target to trigger rate hikes, while the Fed also stands ready to lower rates further if economic conditions turn out to be weaker than it expects. Regarding the situation in the repo market, it appears that the Fed is satisfied with the steps taken so far, with Powell stating that it is not trying to eliminate all volatility in it. The focus rather is on keeping the federal funds rate within the target range. He said that the Fed plans to continue buying T-bills, but would be prepared to buy short-term coupon-bearing bonds if needed.

We continue to recommend a neutral tactical allocation to stocks overall, but prefer US equities to Eurozone ones. This is in part due to central bank policy; the Fed has more leeway to act than the European Central Bank, which has already announced a return to quantitative easing, in the event of a risk scenario in growth or trade. In addition, consensus expectations for earnings growth look more realistic in the US than in the Eurozone, in our view.

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