The Long Pause

The Federal Reserve hiked interest rates for the 9th time this month, bringing the Fed Funds Rate up to a range of 2.25% – 2.50%.

The move should have surprised no one, as the bond market was pricing it in for some time. Over the past 3 years, at every FOMC meeting where the market expected a Fed hike (9 meetings), they got one.

While many were critical of the move, a hike was necessary for the Fed to maintain its credibility. They had been signaling a December hike for months, and had they refrained many would have viewed it as a sign of weakness, bowing to political pressure from President Trump.

But that is the past. Going forward, the every-other-meeting hiking routine is over. While the Fed is still projecting 3 more interest rates hikes in 2019 (down from 4 at the September meeting), they are unlikely to meet this target. Instead, a long pause awaits us.

Why? 6 Reasons…

1) Inflation expectations have plummeted, with 5-year breakevens at their lowest levels in 2 years. The inflationary pressures that we saw earlier in the year are gone, and the Fed now has the luxury of waiting to see if they resurface before hiking again.

2) Global equities are now in a Bear Market, down more than 20%. While the Fed often talks of being “data dependent,” the stock market has long been one of their most important “data” points. In the 2011 Bear Market, the Fed pushed back rate hike expectations (they did not hike until December 2015) and came out with operation twist. At the lows in early 2016, rate hike expectations were again pushed back, and the Fed did not hike until December of that year (only after the equity markets were safely at new all-time highs).

The Fed is subtly sending a similar message today. As the stock market declined over the past few months, Jerome Powell’s definition of “neutral” changed from a “long way from neutral” to “just below” it.

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Disclaimer: At Pension Partners, we use Bonds as our defensive position in our absolute return strategies for all of the above reasons. Bonds have provided a more consistent defensive alternative to ...

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