On the front page of its website, the Federal Reserve, the central bank of the United States (the "Fed”), lists its mission as "providing the nation with a safe, flexible, and stable monetary and financial system”. It accomplishes this through its Monetary Policy, which, in very simplified form, consists of two primary tactics: 1) changes to a benchmark interest rate and 2) changes to the money supply.
On Wednesday, January 30th, the Federal Open Market Committee ("FOMC” or "Committee”) made two key changes in its recent contractionary approach that signal to investors a more measured and cautious approach to monetary policy and economic growth.
- The Fed maintained the target range for its benchmark interest rate at 2.25%-2.5%, a much anticipated pause after the Fed increased interest rates by 0.25% in December – the fourth increase of 2018 and ninth since December of 2015 when it commenced its campaign to normalize rates after the 2008/2009 financial crisis.
- The Fed clarified its plan to reduce its balance sheet, which ballooned to $4.5 trillion in the years after the crisis as the Fed sought to stabilize financial markets and bolster an ailing economy, in a more "accommodative” versus "auto pilot” manner.
From what many investors felt was an overly hawkish and contractionary tone last fall, the Fed Chairman Jerome Powell now seems to have adopted a more dovish and neutral, if not yet fully expansionary, stance. In our opinion, this reversal should take considerable pressure off of the equity markets.
The FOMC Statement on Interest Rates
As we witnessed during the 4th quarter of 2018, the fear of higher interest rates and the resulting tighter economic conditions can take a terrible toll on financial markets even in the wake of full employment, low inflation, solid corporate earnings, low taxes, and in general, a robust US economy.
In their Wednesday, January 30th statement, the Fed outlined that, "After extensive deliberations and thorough review of experience to date the Committee continues to view changes in the target range for the federal funds rate as its primary means for adjusting the stance of monetary policy.”
In our opinion, this Fed statement highlights the overall health of the US economy and the expansion remains intact, albeit at a slower pace and recessionary fears are overblown.
The official statements continued with:
"Information received since the FOMC met in December indicates that the labor market has continued to strengthen and that economic activity has been rising at a solid rate. Job gains have been strong, on average, in recent months, and the unemployment rate has remained low. Household spending has continued to grow strongly, while growth of business fixed investment has moderated from its rapid pace earlier last year. On a 12-month basis, both overall inflation and inflation for items other than food and energy remain near 2 percent, which is recognized as the Fed’s inflation rate objective.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. In support of these goals, the Committee decided to maintain the target range for the federal funds rate at 2.25% to 2.50%. The Committee continues to view sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee's 2 percent objective as the most likely outcomes. In light of global economic and financial developments and muted inflation pressures, the Committee will be patient as it determines what future adjustments to the target range for the federal funds rate may be appropriate to support these outcomes.”
The FOMC Statement on Money Supply
In addition, on Wednesday, the Fed’s biggest action was to clarify its current plan to reduce the size of its balance sheet. The statement read:
"The Committee is prepared to adjust any of the details for completing balance sheet normalization in light of economic and financial conditions. Moreover, the Committee would be prepared to use its full range of tools, including altering the size and composition of its balance sheet, if future economic conditions were to warrant a more accommodative monetary policy than can be achieved solely by reducing the federal funds rate."
In lay terms, this means that the Fed intends to establish an "accommodative monetary policy” not only through the use of interest rates, but also by more cautiously and patiently adjusting the money supply. In recent weeks, the Fed’s plans with regard to the reduction in the size of its balance sheet had become a major focus for investors. Recent commentary on the balance sheet from Fed officials, including Powell, have been market-moving events.
During his December press conference, Powell said the Fed "would effectively have the balance sheet runoff on automatic pilot,” spooking markets with the fear that reductions in the money supply would be too severe and unmonitored. This forced Powell to later clarify his comments as equity markets suffered their deepest correction in nearly a decade. Subsequent softening of their stance as we entered 2019 calmed markets and reduced fear of a recession as a result of Fed policy.
We feel Powell learned a valuable lesson as a new Fed Chair and now realizes that casual statements like "a long way to neutral” and "auto-pilot run off of the balance sheet” are not the seemingly benign messages that equity markets can digest. In sharp contrast, the word "patience” was mentioned 8 times in his news conference in an effort to calm investors’ fears that policy makers were moving too quickly.
Experience has shown us that every single word in a Fed statement is highly scrutinized and compared from statement to statement. The omission or addition of a single world or even the slightest perceived change in sentiment can have dramatic repercussions throughout the financial markets. After watching today’s press conference, it is evident that Jerome Powell learned this lesson.
At WT Wealth Management we believe the economy is healthy despite headwinds such as trade wars, Brexit uncertainty, government shutdowns, political grid lock and the fact that the latest economic expansion is approaching 8 years of age. However, in a consumer driven economy like ours, where consumer spending accounts for over 70% of GDP, we feel the current expansion will continue, most probably at a slower pace, short of the fed killing it through hawkish monetary policy. As always, we continue to monitor and evaluate dozens of key pieces of economic data on a weekly basis and position client accounts accordingly for maximum returns within their specific risk tolerance profiles.