Fed stands pat

A perspective from E*TRADE Capital Management, LLC 01/29/20

On Wednesday, the Federal Reserve once again left short-term interest rates unchanged in a target range of 1.5–1.75%. The decision followed the Federal Open Market Committee’s (FOMC) first meeting of 2020 and was consistent with previous indications the Fed would likely remain on the sidelines, barring any major disruptions in the US economy.

US fed funds target rate

FactSet Research Systems, January 29, 2020

What's new since December?

After cutting interest rates three times in 2019, the Fed closed out the year by holding rates steady at its December 11 meeting. Minutes revealed the board felt an accommodative monetary policy could help the economy recover from waning global growth and the US-China trade war.1

Since then, economic numbers have been somewhat soft, but indicative of expansion. Economic growth has remained positive, albeit low. Third-quarter 2019 GDP came in at 2.1%, a tick up from the previous quarter.2 December employment came in below expectations with weak jobs and wage growth, although unemployment remained at a 50-year low.3 On the upside, retail sales increased for a third-straight month,4 and housing data has generally been strong so far in January.

But manufacturing continues to be a weak spot for the US economy. The Institute for Supply Management’s® manufacturing index fell to 47.2 in the final month of 2019, the lowest level since June 2009.

Also, although the yield curve ended 2019 almost completely normalized, it has more recently flattened, with 3-month T-bills yielding more than 2-year and 5-year T-notes.

Trade landscape improved

Meanwhile, developments on the international front have helped decrease some geopolitical uncertainties. US-China trade tensions have cooled after the countries finalized a phase-one trade deal and the US removed its currency manipulator designation from China. But many tariffs are still in effect and are expected to remain in place until after the November US presidential election, which may continue to drag on an already weak manufacturing sector.

The market is chugging along

The US stock market remains a bright spot as we get into the meat of the Q4 earnings season. Despite the confrontation with Iran at the outset of the year and concerns about the recent coronavirus outbreak, equities are still relatively close to their record highs. Recent high-profile earnings beats, including Apple, Starbucks, and McDonald’s, padded the resume of an already strong reporting season, while better-than-expected consumer confidence and durable goods orders suggested US consumers continue to be a driving force in the economy.

Looking ahead

While expectations are for the Fed to continue to be hands-off in the coming months, probability for a rate cut by the end of 2020 has increased, with the CME FedWatch Tool forecasting a 75% chance of at least one cut by year-end.5 Investors may want to keep an eye on a few catalysts with the potential to bring them off the sidelines:

  • Earnings and guidance. While Q4 2019 earnings growth is expected to decline for a fourth-straight quarter, guidance for 2020 looks more optimistic. But any large-scale shifts in the overall corporate outlook could mean businesses are struggling to reap the benefits of the current low-interest-rate environment.
  • Global trade and politics. In minutes from its previous meeting, the Fed highlighted lingering concerns regarding international trade and weak economic growth abroad.6 A breakdown in trade negotiations with China, unexpected fallout from Brexit, or even supply and demand disruptions from the coronavirus, could lead the Fed to reevaluate its current outlook.
  • Inflation. Following the December FOMC meeting, Fed Chairman Jerome Powell indicated he would need to see a sustained increase in inflation before considering hiking rates.1 After coming in below the Fed’s 2% target range for most of last year, shifting inflation could also shift sentiments for the course of the year.

The Federal Open Market Committee next meets March 17–18. For now, the Fed seems content to stand pat, but changing conditions could alter the monetary policy calculus. Stay the course—but stay on your toes.

  1. The Wall Street Journal, “Fed Minutes Show Comfort With Prolonged Pause on Rates,” January 3, 2020, https://www.wsj.com/articles/fed-minutes-show-comfort-with-prolonged-pause-on-rates-11578078226
  2. US Department of Commerce, Bureau of Economic Analysis, December 20, 2019
  3. Bloomberg, “U.S. Jobs Trail Forecasts; Wages Rise Least Since Mid-2018,” January 10, 2020, https://www.bloomberg.com/news/articles/2020-01-10/u-s-payrolls-trail-forecasts-wages-rise-least-since-mid-2018
  4. Trading Economics, US Retail Sales, January 16, 2020
  5. CME FedWatch Tool, as of January 28, 2020
  6. Federal Reserve, Minutes of the Federal Open Market Committee December 10–11, 2019, https://www.federalreserve.gov/monetarypolicy/files/fomcminutes20191211.pdf

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