Dovish Fed Policy Supportive of Continued Economic Growth
Marco Fragnito | Managing Principal | PRINTER FRIENDLY VERSION
- The June Fed FOMC meeting signaled dovishness reinforcing investors’ expectations of a rate cut announcement at the next FOMC meeting: July 30-31.
- The yield curve has now inverted all the way from the short dated three-month T-Bills and is becoming a legitimate concern for markets.
- Economic activity has slowed, especially abroad, but domestic growth continues, and a Fed rate cut should maintain the economic expansion in our view.
The S&P 500 registered its best performance for the month of June since 1955. Driven by a dovish Federal Open Market Committee (FOMC) meeting, the S&P 500 rose 6.9%, hitting a new all-time high. While the Dow Jones Industrial Average (DJIA) and NASDAQ Composite saw even better gains, respectively rising 7.2% and 7.4% falling just short of record highs.
In our last monthly commentary, we stressed the need for investors to focus on the Federal Reserve’s upcoming meeting for insight into the direction of equity markets. With the Federal Reserve board members sounding decidedly more dovish going into the FOMC meeting and Chairman Powell confirming those views in his post meeting press conference, equity markets took their cue and moved decidedly higher. Powell stated that “overall, our policy discussions focused on the appropriate response to the uncertain environment,” and that “many participants believe some cut to the Fed-funds rate would be appropriate in the scenario they see most likely.”
By the close of the month, Fed-Funds futures data tracked by the CME Group were forecasting with 100% probability of a ¼% cut at the July FOMC meeting and for at least one more by year’s end. Soft economic data announced throughout the month of June further supported market expectations for interest rate cuts into the second half of the year.
International equity markets also gained on the prospect of looser monetary policy across the globe and signs of renewed trade negotiations between the US and China. Foreign economies continue to remain vulnerable to further economic weakness due to the inability or unwillingness of their governments to undertake more stimulus fiscal policies. We see this in Europe, where the reliance on monetary policy rather than reforming fiscal policy has left their economies in a virtual state of stagnation. We believe that pro-growth fiscal policies are required in many of the world’s economies and especially across the Eurozone to lift economic growth, and in turn boosting global growth.
The economic data in June continued to disappoint. The US Labor department reported that May non-farm payrolls gained only 75,000 new jobs versus expectations for a gain of 185,000. While manufacturing continued to slow with the Institute of Supply Management gauges coming in at their lowest levels since October of 2016. This further supported market expectations for the need to lower interest rates into the second half of the year and drove US Treasury yields down across the curve. The yield curve has now inverted all the way from the short dated three-month Treasury Bills and is becoming a legitimate concern for markets and us at MCF. Should the Federal Reserve not act at its July FOMC meeting, we believe it would prove to be a negative for financial markets and greatly raise the odds of a recession in the coming year.
With the Federal Reserve acknowledging the downside risks and economic uncertainty that lie outside our borders, combined with continued mixed domestic economic data, we feel confident that they will act to maintain the expansion. Of note, the June non-farm payrolls came in much stronger than expectations with job gains posting an increase of 224,000 versus 160,000 expected—a sign that while the economy has slowed it continues to grow. An ever so slightly more accommodative monetary policy can provide the needed support to overcome any economic uncertainties that may persist.
We remain bullish on domestic equity markets as we have for most of this year, and our equity portfolios continue to perform well in this market environment. Based on Fed Chairman Powell and the FOMC statement delivered after their last meetings, we expect interest rates as measured by the Fed-funds to be cut by 25 basis points (100 basis points equals 1 percent) at their July meeting. We further expect a cut of 25 basis points by year end. This will bring short term interest rates back to 2% which we believe for several reasons to be the neutral rate given present economic conditions.
We would view any further reductions in interest rates beyond that point to imply that the economy is weakening much more, having negative implications for corporate revenue and earnings estimates going forward. This would lead us to turn much more cautious on equity markets. Finally, we would recommend investors look to sell any long-term bond holdings, we feel they are vulnerable to a large sell off should easing monetary policy succeed in re-accelerating economic growth.
If you have any questions please contact us directly at 949.472.4579, and feel free to forward this report and our contact information to anyone who might be interested.
Sources: Wells Fargo Advisors, Angela Shin, “Monthly Market Commentary,” July 2, 2019.
The opinions expressed here reflect the judgement of the author(s) as of this date and are subject to change without notice. Information presented here is for informational purposes only and does not intend to make an offer, solicitation, or recommendation for the sale or purchase of any product, security, or investment strategy. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed here. The information being provided is strictly as a courtesy.
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