WHAT WAS THE IMPACT OF THE FED ON MARKETS?
April 2019 | Marco Fragnito | Managing Principal
- The Fed’s dovishness after FOMC, a positive signal to equity markets in Q1, 2019.
- Corporate earnings in the coming weeks are likely to beat as many analysts have reduced expectations.
Equity Markets saw their best quarterly performance in a decade. Despite concerns of slowing global growth and misplaced fears of a late quarter yield curve inversion. Investor sentiment continued to be lifted by the Federal Reserve more patient approach to monetary policy. The Dow Jones Industrial average managed a slight gain for the month March, while the S&P 500 and the Nasdaq Composite Posted respectable gains of 1.8% and 2.6%.
Yield curve inversion occurs when yield on the Fed-sensitive 3-month Treasury Bills rise above the benchmark 10-year Treasury Note. While a yield curve inversion has an inviable record of predicting every US recession since 1975, it must remain so for an extended period rather than a couple of days or hours to be truly noteworthy. Fed Futures, as tracked by the CME Group, were beginning to price in a better than 60% chance of a rate cut by the 4th quarter, dispelling the notion of a sustained yield curve inversion.
The Federal Reserve’s dovish tone remained in focus for the bond market. This was further confirmed following the FOMC meeting where the Fed projected no interest rate hikes in 2019. Furthermore, the Fed also announced a slowdown in the pace of shrinking of its balance sheet and an end to the run-off by September. This was in sharp contrast to its December meeting where the FOMC projected two rate hikes in 2019 and keeping the balance sheet run-off on “autopilot.” Combine that with Chairman Powell reiterating his belief that “the US economy is in a good place,” it became evident to investors that the Fed had become much more economic data dependent and was slowly moving from a tightening bias to neutral or even a loosening one.
With recent global economic data showing further weakening combined with mixed readings in the US, the Fed’s change in monetary policy appeared appropriate and timely. Chinese industrial output increased at the slowest pace since 2002, with their exports declining 20%, European factory output slowing the most in six years and US payroll rising a mere 20,000 in the month of February, the slowest since September of 2017 was evidence of a slowdown. This led to a strong rally across the yield curve with the benchmark 10-year note yield falling to a 15-month low of 2.34%. While commodities rose strongly with West Texas Intermediate crude leading the way to its best quarterly performance since 2009—a sign that markets may already be anticipating a mild slowdown with no recession.
We continue to remain bullish on equity markets, especially in the US. With the Fed indicating it is prepared to keep interest rates steady to possibly lowering them if necessary, we expect the economy to rebound in the second half of this year. The impact of potentially easier monetary conditions proved very supportive of equities in the first quarter. We also expect earnings in the coming weeks to beat reduced expectations, further providing support to markets. We believe that monetary conditions will prove instrumental in determining equity market direction and will continue to monitor interest rate expectations closely to help determine our asset allocation.
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Sources: Wells Fargo Advisors, Angela Shin, “Monthly Market Commentary,” April 2, 2019.
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