The Fed may pause normalization and rate hikes
The FOMC minutes noted that “almost all participants thought that it would
be desirable to announce before too long a plan to stop reducing the
Federal Reserve’s asset holdings later this year.” This came as a surprise
to many investors, especially after Fed Chair Jerome Powell insisted just a
few months ago that balance sheet normalization would remain on autopilot.
In my view, the likelihood that the Fed may stop the balance sheet
reduction this year should be positive for risk assets given the impact
quantitative easing had on them. In other words, the “Fed put” appears to
be alive and well.
In addition, the Fed appears to be hitting the pause button on rate hikes –
at least for the time being. According to the minutes, “…many participants
suggested that it was not yet clear what adjustments to the target range
for the federal funds rate may be appropriate later this year.” Not only is
the Fed likely to sit on its hands with regard to rate hikes in coming
months, but some Fed watchers are suggesting that the Fed’s next move, when
it occurs, might be a rate cut. While that seems quite unlikely at this
juncture, it does seem clear to me that the Fed doesn’t have great clarity
on the state of the economy. However, it can take the time to get a better
grasp of it.
U.S.-China trade talks bring progress and new uncertainties
In the last several days, reports suggest significant progress has been
made in the U.S.-China trade talks, with U.S. President Donald Trump
tweeting last week, “We’re doing spectacular things on trade.” Trump said
he will extend the March 1 deadline for tariffs because so much progress
has been made.1
My understanding was that the agreement would include critical issues such
as access to markets, forced technology transfer, and intellectual property
rights – that certainly has been the goal of the U.S. Trade Representative,
Robert Lighthizer. However, I never expected China to make any material
concessions in those areas – certainly not this quickly. And Chinese
officials have warned that while progress has been made, there may be “new
uncertainties” given that U.S.-China trade conflicts are “long-term,
complicated and arduous.”2
I believe any fast resolution to the trade wars between the U.S. and China
will likely come because Trump is willing to take concessions on the trade
deficit just to end the trade war. And that is what appears to be
happening, with U.S. Agricultural Secretary Sonny Perdue praising China’s
agreement to purchase tons of soybeans, a much-needed help to U.S. soybean
farmers who have been hurt by the trade wars and have been unable to sell
What could all this mean for stocks?
You may recall that the fourth-quarter stock market selloff could largely
be attributed to the two key risks we had been discussing all last year:
tariff wars and monetary policy normalization. The catalysts for the
October market drop were:
A growing recognition that the U.S.-China trade conflict was having an
impact on the economy and corporate profit margins. (The International
Monetary Fund downgraded economic growth estimates for 2019 and beyond
partly because of the trade situation, and we got comments during
third-quarter earnings calls from some industrial companies indicating that
input costs are increasing, and supply chains are being disrupted.)
Powell’s statements that Fed rate hikes were “a long way” from getting
rates to neutral.
Risk asset weakness continued in the fourth quarter under the weight of
these two concerns. As recently as Dec. 19, at the FOMC meeting press
conference, Powell insisted that balance sheet normalization would remain
on autopilot, explaining, “I think that the runoff of the balance sheet has
been smooth and has served its purpose, and I don’t see us changing that.”
And so what happened this past week suggests that both those risks have
receded, clearing the way for stocks to move higher.
Or does it?
Could such a dramatic change from the Fed be a cause for alarm instead?
First of all, recall that when former Fed Chair Janet Yellen introduced
balance sheet normalization in 2017, she was clear that the process would
be on autopilot with no alterations or reversion back to quantitative
easing unless there was a “sufficient” negative shock to the economy. We
have to wonder – and worry – about what the Fed is seeing or expecting that
has caused them to consider not only scaling back balance sheet
normalization, but actually ending it this year.
This calls to mind the old adage, “Be careful what you wish for.” Yes, I
believe balance sheet normalization has created disruption – particularly
in emerging markets where it was causing a “liquidity suck.” I also believe
it has created a headwind for equities, especially when the Fed has
insisted it would remain on autopilot. I would have welcomed a dialing down
of balance sheet normalization or a data-dependent normalization process,
but a complete cessation in balance sheet normalization this year worries
me. Not only because we have to wonder what is causing this change in
position by the Fed, but because it suggests the Fed will still have a
bloated balance sheet by the time the next crisis rolls around – and
therefore might not have enough dry powder to combat it. The pessimist in
me wonders if the Fed, in the face of the next crisis, will be forced to
resort to other experimental tools…perhaps helicopter money?
In addition, given that we have experienced apparent progress many times
before, we have to temper enthusiasm for signs of a resolution to the
U.S.-China trade wars – not only because the Lighthizer camp might throw a
wrench into an easy resolution, but because if it’s resolved, it may mean
that the U.S. can quickly launch into a trade war with the European Union
But, for now, both these developments suggest a more positive environment
for U.S. equities, which I believe is likely to spill over into a positive
environment for global equities in general. But I would advise caution as
we follow both situations closely.
is Global Market Strategist at Invesco. This article first appeared in
the Invesco blog.
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1 Source: Chinese National Bureau of Statistics, as of December 31, 2018
2 Source: U.S. Bureau of Labor Statistics, as of January 4, 2019
Purchasing Managers Indexes are based on monthly surveys of companies
worldwide, and gauge business conditions within the manufacturing and
The ISM Manufacturing Index, which is based on Institute of Supply
Management surveys of more than 300 manufacturing firms, monitors
employment, production inventories, new orders and supplier deliveries.
Fed funds futures are financial contracts that represent the market’s
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future. The federal funds rate is the rate at which banks lend balances to
each other overnight.
The Eurozone Manufacturing PMI® (Purchasing Managers’ Index®) is produced
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panel of around 3,000 manufacturing firms. National data are included for
Germany, France, Italy, Spain, the Netherlands, Austria, the Republic of
Ireland and Greece.
Safe havens are investments that are expected to hold or increase their
value in volatile markets.
The opinions referenced above are those of Kristina Hooper as of Jan. 7,
2018. These comments should not be construed as recommendations, but as an
illustration of broader themes. Forward-looking statements are not
guarantees of future results. They involve risks, uncertainties and
assumptions; there can be no assurance that actual results will not differ
materially from expectations.
© 2019 by Invesco Canada Ltd. Reprinted with permission.