Federal Reserve Update
Earlier on Wednesday, the Federal Reserve Open Market Committee (FOMC) raised the fed funds target rate by 0.25% to a new level of 2.25-2.50%, which was widely anticipated.
The formal Federal Reserve statement was little altered from November, since it noted that economic activity remained strong, unemployment remained low, household spending has grown, business fixed income has moderated, and that inflation remains near the policy target. However, there was a tempering of language in terms of further rate hikes as well as a comment that the Fed ‘will continue to monitor global economic and financial developments’ for assessment of future policy actions. Overall, the updated economic commentary pointed to a base case of about two interest rate increases next year.
Of late, the issue has been a pause in economic acceleration, which has fueled fears that the peak in economic activity has been reached, and that an eventual slowdown and recession might be the next stop. However, it is possible that this assumption may still prove premature. In keeping with changing economic data, what was once thought of as a done deal, i.e. a continuation of this same pace of rate hikes into 2019, is now looking far less certain. Initial estimates by a variety of economists of 2-4 hikes next year have fallen back to 1-2 hikes, in keeping with the Federal Reserve's assumptions, with the Fed policy continuing to be even more ‘data dependent’ than usual. Fed Chairman Jerome Powell’s comments during the last several weeks have confused markets a bit, with his comments in October alluding to the current fed funds rate being ‘far below’ the Neutral level, while more recent discussions have suggested that the current rate is ‘just below’ the Neutral level.
Equity and credit markets have been on edge this quarter, bucking the often-quoted ‘Santa Claus Rally’ tendency (which usually implies that December has often been one of the most positive equity months over the past century). The point of contention appears to be whether the economy is in transition from economic growth to deceleration, and eventually recession. Typically, catalysts for recessions included overheating in certain segments, general financial imbalances or rapid interest rate hikes from the Federal Reserve, none of which have occurred to date. However, the 2019 market environment does face a variety of wild cards such as the ongoing U.S.-China trade spat, possibility of a ‘hard’ Brexit and faster-than-market implied interest rate hikes.