New year, new Fed?
12/27/18

●The market typically reacts negatively to Fed surprises

●Investors are still hopeful the Fed will raise interest rates at a slower rate


 

While a year ago there was a fairly broad consensus that the Federal Reserve was going to raise interest rates in 2018, there seems to be much less agreement these days about what the Fed may do in the upcoming year.

The Fed’s November 8 statement showed its positive economic outlook (and, by implication, its inclination to continue raising interest rates) was still intact less than two months ago: “Information received since the Federal Open Market Committee met in September indicates that the labor market has continued to strengthen and that economic activity has been rising at a strong rate.”

But some soft economic numbers and, perhaps, a renewed stock market downturn (not that the Fed would ever admit that) appeared to open the door to a central bank that is potentially less eager to hike rates. On November 28, Fed chair Jerome Powell gave stocks a huge (if short-lived) shot in the arm when he said the Fed funds rate was “just below” a desirable level for a healthy economy.1

But three weeks later, on December 19 the Fed caught some market players leaning the wrong way by hiking rates one last time in 2018, although it also announced its expectations to raise rates only two times in 2019.2 The S&P 500, which had been up more than 1% prior to the announcement, immediately broke to the downside and dipped into negative territory within 25 minutes after the news.

S&P 500 (SPX), 11/20/18–12/19/18. S&P 500 (SPX) price chart. Fed boost, Fed bust

Source: Power E*TRADE


Fed monetary policy has two components—what the bank does, and the extent to which its actions surprise the market. The Fed has long attempted to “telegraph” its intentions to the market to avoid catching market participants off guard. Last Wednesday’s intraday selloff was an example of what can happen when the Fed does something even a little unexpected.

Of course, the US stock market would prefer lower rates to higher ones, so any indication that the Fed is going to deviate from its most recently telegraphed position—that next year will bring only two rate hikes—could rock the market.

So don’t just wait for scheduled Fed meetings and announcements—keep tabs on what the central banks says between them for clues about changes in its stance.

Today’s numbers (all times ET): FHFA House Price Index (9 a.m.), New Home Sales (10 a.m.), Consumer Confidence (10 a.m.), EIA Natural Gas Report (10:30 a.m.), EIA Petroleum Status Report (11 a.m.).

 

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1 Reuters. Wall Street jumps as Powell hints interest rate hikes may taper off. 12/28/18.

2 Bloomberg.com. Fed Raises Rates, Trims Forecast for Hikes in 2019 to Two. 12/19/18.