Fed building. Fed building. Fed building.
November 29, 2018

While there are several reasons that are behind the recent stock market volatility, the swift upward jump in interest rates has undoubtedly been a significant contributor.  The absolute level of rates, however, has not been the primary concern. That honor belongs to the seemingly unwavering stance of the Federal Reserve around its desire to continue raising rates in the face a slowdown in global growth prospects. We have always felt the Fed, and Chairman Powell in particular, would take a more pragmatic approach on this front than that implied by the most recent Federal Reserve forecast. Indeed, Fed Chairman Powell’s opening statement on Wednesday, November 28th to the Economic Club of New York included an important shift in the language characterizing the future path of interest rates. Specifically, Chairman Powell said, “Interest rates . . . remain just below the broad range of estimates of the level that would be neutral for the economy‑‑that is, neither speeding up nor slowing down growth.”

This statement could be parsed indifferent ways, but the main import for the markets is its contrast to the Chairman’s previous comment on October 3rd where he stated, “We may go past neutral, but we’re a long way from neutral at this point, probably.”

That idea of both being a “long way from neutral” and also the idea of going past neutral contributed to the equity market’s selloff of the past two months. There was simply no light at the end of the rate hike tunnel. Today, while the markets don’t expect that rate hikes are finished, there is light. 

Taken together with dovish comments recently by Fed Vice-Chair Richard Clarida that interest rates are close to neutral, the markets have begun to price in this tone shift.  After Chairman Powell’s comments hit the wires, the S&P 500 shot up immediately and finished the day up over 2%. The U.S. dollar index, whose strength has plagued emerging markets for the past several months, fell over 0.5% on the day as well. 

We have been expecting such a Fed softening to occur in upcoming months, but not this quickly. We believe that the Fed is coming around to the notion that slowing global growth, tame inflation, and a weakening housing market are not given to a continued aggressive rate hike trajectory. This change of tenor also fits with our longstanding belief that Chairman Powell is not dogmatic in his views. Chairman Powell further noted in his remarks that, “We also know that the economic effects of our gradual rate increases are uncertain, and may take a year or more to be fully realized,” which we also believe has dovish implications for 2019 rate hike realizations. The futures market pricing of Fed rate hikes (Exhibit #1) shifted only modestly on the news as those expectations were already well below the Fed’s “Dot Plot” (Exhibit #2) from its previous meeting. With today’s statement, however, there is less risk of overtightening. 

 

Exhibit 1: Fed Rate Path: Market Outlook (11/28/2018)

Source: Bloomberg FInanical 

 

Exhibit 2: Federal Open Market Committee (FOMC) "Dot Plot" 

Source: Federal Reserve: BMO Wealth Management Strategy

 

Despite the strong one-day reaction, this does not by itself mark an “all clear” signal for the equity markets and an end to recent volatility. The Fed will most likely continue to be data dependent, trade wars and tariff concerns are still in a state of heightened uncertainty, and the oil price finished the day noticeably lower which served as a reminder that the slowing global growth is not likely to reverse course anytime soon. Still, at the margin, Chairman Powell’s remarks represent good news. Unless we get blindsided along the way, it seems the end of the Fed rate hike tunnel is in sight.

 

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