STA Weekly Report – Are We Close to the End of The Interest Rate Hiking Cycle
Written by Luke Patterson | Friday, March 29th, 2019
INSIDE THIS EDITION: Are We Close to the End of the Interest Rate Hiking Cycle? Major Stock Indexes Maintain Their 2019 Uptrends Retirement income and Inflation 401k Plan Manager*Updated on 12/31/2018
The U.S. Federal Reserve ended their two-day FOMC (Federal Open Market Committee) meeting on March 20th keeping the interest rate unchanged. This was widely expected, given that the Fed signaled a dovish stance in January by saying they would adopt a patient, wait-and-see attitude on rates.
What was unexpected however, was that many Fed officials (11 of the 17 FOMC members) didn’t think even one increase in rates would be needed this year. Furthermore, 7 members believed that rates should remain unchanged through 2020. In fact, the median of FOMC member’s dot projections suggest that the central bank only plans to increase rates once in 2020 and is likely to leave rates unchanged in 2021.
The current view from the Fed represents a big shift from the December meeting, when the median rate expectation for 2019, 2020, and 2021 was 50 bps higher. What has made the Fed change its mind in merely three months? We think three factors contributed: a sharp slowdown in global growth, muted inflation pressure, and tighter financial conditions. In our opinion, the Fed has made the right call by pivoting from further gradual rate hikes. We are not surprised by the dovish Fed, because deteriorating macroeconomic fundamentals do not support continuous tightening of monetary policy, as we pointed out in our newsletter on March 13th. The key question now becomes: is the Fed done in this cycle or just pausing before resuming hikes? We lean toward the former, but the ultimate path of interest rates will depend on economic-, policy-, and geopolitical- developments in coming months.
Interestingly, the bond market is more bearish as investors have dramatically downgraded their view on economic growth over the course of 2019. While the Fed projects one rate increase in 2020, the bond market believes that rate cuts should occur instead.
To put it in statistical terms, the bond market currently
sees a 76% probability of a rate cut and 0% odds of rate hike in 2019.
Because of increasing expectations for a recession
approaching and the Fed’s need to potentially cut rates again to stimulate the
economy, parts of the yield curve have inverted, with the yield on the 1-year
and 10-year Treasury bonds lower than yields on 3-month and 6-month T-bills.
By now, you should be asking what the investment implications of this yield curve inversion might be. Historically, an inverted yield curve can signal that a recession is looming, with a notable exception in mid-1998. Back then, the Fed paused their rate hiking cycle, which eased financial conditions and delayed a recession for nearly three years.
Whether the yield curve inversion is predicting the next recession or not, it is a useful warning sign. Especially, when the market believes the growth outlook is deteriorating. However, it is important to note that slow growth like we have today doesn’t mean negative growth and a recession. In our view, the market may be a bit premature in pricing in rate cuts but favor caution on the rich valuations we see in the intermediate and long-term segments of the US yield curve.
Major Stock Indexes Maintain Their 2019 Uptrends
Major U.S. stock indexes appear on track end the week and quarter with their 2019 uptrends intact.
Chart 1 shows the Dow Industrials in a sideways trading pattern over the last month. This week’s pullback bounced off its (blue) 50-day average. And it appears to be regaining its (green) 20-day line today. It still needs to clear its first quarter highs to resume its uptrend. But it’s 2019 uptrend in still intact. Chart 2 shows the S&P 500finding support at its green 20-day average; and remaining well above its 50- and 200-day lines. The SPX also remains above chart support near 2800. Chart 3 shows the Nasdaq Composite Index still trading above its green 20-day average. It look at midweek like the Nasdaq (and other stock indexes) might retest its (red) 200-day line. But it’s ending the week well above that long-term support line. Falling bond yields earlier the week caused some profit-taking in stocks. A slight rebound in bond yields may be helping stabilize stock prices.
Andrei Costas, Senior
Investment Analyst (Equity Strategies)
Nan Lu, Senior Investment Analyst (Fixed Income Strategies)
Retirement Income and Inflation
By: Scott Bishop, MBA, CPA/PFS, CFP®
During your working years, you’ve probably set aside funds in retirement accounts such as IRAs, 401(k)s, or other workplace savings plans, as well as in taxable accounts. Your challenge during retirement is to convert those savings into an ongoing income stream that will provide adequate income throughout your retirement years.
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