Doves Fly As Fed Keeps Rates Unchanged, Signals Easy Policy For Rest of Year

The stock market surged and Treasury yields lagged after the Fed decided to keep rates unchanged and signaled a dovish policy going forward. The Fed also cited a slowing U.S. economy.

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6 min read

Key Takeaways

  • Fed keeps rates unchanged, as markets had priced in

  • Stocks appear to get lift from dovish Fed outlook

  • Dollar, Treasury yields both falling

(Wednesday Post-Fed) If anyone was losing sleep about the prospect of the Fed getting more hawkish in coming months, it looks like they might be able to grab some shut-eye. Today, citing slowing economic growth, the Fed held rates steady and sent strong signals that there might be no more rate hikes at all this year. 

Going into the meeting, many investors had been thinking the Fed might have another 2019 hike in its pocket, but this brings that into question. The Fed’s dovishness today was more pronounced than we’ve seen in the recent past, and that appeared to send stocks higher and Treasury yields lower in the immediate wake of the decision. The dollar, meanwhile, tumbled to a six-week low.

Most Fed officials whose estimates appeared in a new “dot plot” projecting future rates forecast no increase in 2019. The Fed also reduced its expectations for U.S. economic growth and inflation and raised its projection for unemployment. None of this would appear too surprising, judging from comments Fed Chair Jerome Powell and other Fed officials have made recently about the slowing economy, and from the latest set of benign inflation data.

Though stocks initially reacted positively to the Fed announcement, it’s not necessarily positive for the economy to see the Fed cut its GDP estimate for 2019 to 2.1% from 2.3%. It also trimmed its Personal Consumption Expenditures (PCE) inflation forecast to 1.8% from 1.9%. 

The Fed said economic growth has “slowed” from Q4, and that job growth has been “solid.” It previously had called job growth “strong.”

“Recent indicators point to slower growth of household spending and business fixed investment in the first quarter,” the Fed said in updated language from the previous statement.

Trade Situation Might Have Played Into Fed Decision

This might square with news that just came out this morning, when FedEx (FDX) reported weaker than expected earnings and sales, while reducing guidance as it cited a weak international trade situation (see more below). Seeing the Fed drop its productivity estimate for the U.S. even as FDX and other companies report troubles in their international markets seems to tie many of today’s stories together, especially how the trade battle with China might be hurting the economy.

In another move likely to get a close look from many investors, the Fed said it plans to start tapering its balance-sheet runoff in May, ending in September. That’s probably not a surprise, because the Fed foreshadowed this with comments members made in recent speeches. By slowing and then ending the balance-sheet reduction, the Fed could be hoping to give the economy a little stimulus without taking the more dramatic step of lowering rates.

However, it doesn’t look like all the investors out there necessarily agree that adjusting its balance sheet strategy will provide the Fed enough ammunition as the economy slows. Chances of a Fed rate cut by the end of the year quickly climbed to above 35% after the Fed decision, according to the CME futures market. The odds had been around 22% earlier this week.

Checking the Dots

Along with its statement, the Fed issued an updated “dot plot” showing where Fed officials see rates going in coming years. 

What might have been surprising was the Fed’s forecast not only for no change in rates this year, but for rates to be 50 basis points lower by the end of 2020 than it had forecast just three months ago. Back in December, the Fed had forecast rates to be in a range between 2.9% and 3.4% by the end of next year. Now the range is 2.4% to 2.9%.

Looking at the last dot plot vs. the new one side by side, it seems pretty striking how estimates have come down. That’s especially true for next year, which looks far less hawkish than expectations a few months ago.

In his post-meeting press conference, Powell said weakening economies in Europe and Asia are weighing on the U.S. economy.

Stocks have been on a tear thanks in part to the Fed’s desire to stay “patient” and watch the data come in. At the same time, U.S. benchmark 10-year Treasury yields traded near two-month lows below 2.59% before the Fed’s decision Wednesday. Rates have fallen from above 3.2% last fall as investors factor out chances of more Fed rate hikes and as the global economy slows. Weakness from China and Europe might both be factoring into the lower borrowing costs. 

One thing investors might want to consider keeping in mind as they pore over the Fed’s statement and check in on Powell’s press conference is for any hint of where the Fed now sees the so-called “neutral” short-term rate. That’s the level where the Fed believes rates aren’t too tight or too loose. In December, this level ranged between 2.5% and 3.5%, according to Fed officials. The Fed’s benchmark rate now is between 2.25% and 2.5%. If the neutral level comes down, The Wall Street Journal noted, that could imply that the Fed sees less need for future rate hikes.

President’s Words on China Seem to Unsettle Markets

Before the Fed decision Wednesday, U.S. stock indices took a dive as concerns grew over the tariff situation. This seemed to be driven by comments made by President Trump and reported by several media outlets that he’s prepared to leave tariffs in place on Chinese goods for a “substantial amount of time.”

According to The Wall Street Journal, Trump said he isn’t considering removing the tariffs on China because he wants to make sure China “lives by the deal.” Before today, there was hope that a deal might mean an end or at least a cut in U.S. and Chinese tariffs on each others’ goods.

The U.S. has levied tariffs on $250 billion of Chinese goods, about half the value of all Chinese exports to the U.S. Beijing has retaliated with tariffs on $110 billion of U.S. goods, about 90% of what the U.S. exports to China. After Trump’s words, shares of some China-sensitive stocks like Caterpillar (CAT) and Deere (DE) both fell, and semiconductors—another area with wide exposure to China—also weakened.

The rough patch for Wall Street before the Fed decision accompanied both Trump’s latest words and a media report yesterday questioning progress in the negotiations. It looks like the market remains on tenterhooks regarding trade, and the FedEx (FDX) earnings this morning where the company talked about a soft international trade situation appeared to add to investors’ jitters.

Stocks and Treasuries have both been steadily climbing. That’s kind of an unusual situation. Ten-year yields are at two-month lows below 2.6%, while stocks surged back from early weakness Wednesday after the Fed decision.

Wild Day On Wall Street: This intraday chart for Wednesday shows the S&P 500 (candelstick) falling quickly on China worries before surging higher after the Fed decision. Meanwhile, the 10-year Treasury yield (purple line) fell fast as the Fed indicated more dovishness. Data Sources: S&P Dow Jones Indices, Cboe.  Chart source: The thinkorswim® platform from TD AmeritradeFor illustrative purposes only. Past performance does not guarantee future results. 

Close Approach: Earlier this week before the Fed meeting, the S&P 500 Index (SPX) briefly came within 100 points of its all-time intraday high of 2940.9 posted last Sept. 20. It hit 2852 Tuesday before sliding on a report of possible U.S./China trade talk troubles. Some analysts are wondering if the SPX, now up more than 12% year-to-date, may have gotten a bit ahead of itself with the sharp rally since Christmas Eve. The rally has stretched the forward price-to-earnings (P/E) ratio to around 16.3 on the S&P 500, FactSet reported, up from holiday lows below 14. While the P/E is now below the five-year average, it’s well above the 10-year average. 

It looks like some investors began getting comfortable with a higher P/E once the Fed announced its intention to retreat on rate hikes earlier this year, at least judging from market action. However, if investors see any signs of hawkishness in the Fed’s language that just got released, the higher P/E could come into question. That’s also taking into account that analysts widely expect Q1 earnings to fall year over year, and also that the China trade situation—another factor where optimism has arguably helped lead the P/E higher—remains unresolved.

Dollar Watch: The Fed’s retreat from rate hikes might be one factor keeping the Dollar Index a bit soft this week. In the hours before the Fed meeting concluded, the Dollar Index traded near 96.40, down from highs above 97.6 earlier this month. The dollar has been oscillating a bit but staying in a relatively tight range between about 95 and 97.5 over the last three months. A dovish Fed policy might normally be associated with a weaker dollar, but the dollar could also be drawing some strength from worries about U.S./China trade, Brexit, and Europe’s slowing economy. 

At its current level, the dollar is near the middle of a longer-term range between roughly 89 and 103 over the last three years. Some U.S. multinationals have reported the dollar weighing on international sales, but it doesn’t seem to be at levels yet that would necessarily cause major problems. 

Crude Conditions: The dollar’s recent bout of weakness might be helping crude oil a bit. Crude, which is priced in dollars, tends to move inversely to the dollar. Crude futures appeared to get another jolt of bullish buying earlier Wednesday and briefly topped $60 a barrel for the first time since November after the U.S. government reported a much bigger than expected weekly inventory draw of 9.6 million barrels. U.S. crude oil inventories are about 2% below the five year average for this time of year, the government said, and gasoline inventories also fell pretty dramatically. 

On the one hand, this is arguably good news. It seems to imply that the U.S. economy is spinning along pretty well, something that might also be seen from recent strong data elsewhere. On another note, it might be evidence of just how dependent the economy is getting on higher U.S. crude production. The U.S. produced 12.1 million barrels of oil a day last week, near all-time highs and up from 10.4 million a day last year at this time. It’s kind of interesting to think about where crude prices might be without that extra 1.7 million barrels a day of U.S. production year-over-year, especially with OPEC continuing to produce at a reduced level. OPEC production is down around 1.5 million barrels a day from its 2017 average. It’s also a bit alarming to think of just how pricey oil might be now if U.S. production had never moved up from historic lows of around 5 million barrels a day back in the years between 2005 and 2008.

Good Trading, 

JJ

@TDAJJKinahan 

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Economic calendar for week of March 18. Source: Briefing.com
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Key Takeaways

  • Fed keeps rates unchanged, as markets had priced in

  • Stocks appear to get lift from dovish Fed outlook

  • Dollar, Treasury yields both falling

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