The Fed Pivot


In our last newsletter we wrote, “although the Federal Reserve will pause and continue to be data dependent, unlike some of his predecessors, Jay Powell will continue to formulate policy based on the goings-on of Main Street. The liquidity flow from Wall Street to Main Street will continue, and as a result, the Fed will continue with QT and be more hawkish than the market will like.” While future Fed action is never certain, the statements and musings from Fed governors since the beginning of the year have been considerably more dovish than we expected and force us to reconsider Powell and his monetary doctrine.

There is a real possibility that the Federal Reserve will pare back its Quantitative Tightening (QT) program by the end of the year. Structurally, we think this is a mistake since the Fed’s balance sheet has very little impact on overall economic activity. The pivot in policy is a retrenchment back to the decade-long precedent of formulating monetary policy based on asset prices. We have always viewed the “third mandate” of the Fed as a structural mistake. Look no further than the health of the Eurozone and Japanese economies to illustrate the negative effects of bloated Central Bank balance sheets. They restrict capital market function, hurt bank profitability, and incentivize risky corporate and consumer behavior. Nevertheless, it is not our job to formulate solid monetary policy. It is our job to invest given the structural forces that are in place and fighting the Fed has never been a recipe for success. 

The willingness of the Federal Reserve to turn tail and reverse their QT program in the face of a 20% decline in equity values, reveals that they still view their balance sheet as a viable monetary tool. Despite there being no concrete evidence that Quantitative Easing (QE) does anything to help the underlying economy, it seems the Fed is still open to using it. As such, the dichotomy between Main Street and Wall Street we referenced in our last newsletter is considerably less pronounced given the Fed pivot. Multiple contractions is less of a risk in 2019 than we had assumed. The pivot does not make us bullish risk assets, but it does reveal a “Powell Put” that is much higher than we had originally opined. The performance of equity markets since the beginning of 2019 has no doubt incorporated this notion - the consternation that Powell would not protect asset prices has been eliminated. It is very plausible that when the Fed is finally confronted with a choice between stimulating asset prices and fighting inflation, they will opt for the former.

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Disclosure: This article is distributed for informational purposes only and should not be considered investment advice or a recommendation of any particular security, strategy or investment product. ...

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