Markets expected forbearance from the Federal Reserve, but the US central bank Wednesday leaned further towards monetary ease than the optimists expected. The Fed envisions no change in interest rates until sometime in 2020, and not at all if the economy weakens further. It won’t reduce the $4 trillion securities portfolio it built up through so-called quantitative easing.
This is a market that rewards cowardice – holdings of stable income-earning assets like credit and real estate – more than it rewards bravery. I continue to believe that carry will be king in 2019 as the Fed keeps interest rates low.
I noted yesterday that the weakness in the US consumer sector had registered in forward-looking equity prices as well as backward-looking data on spending. The US consumer has been the marginal provider of demand in the world economy, and continues to represent the biggest risk to the world economy. All signals pointed to a sharp slowdown in economic growth, which the Federal Reserve more or less acknowledged.
For the most part, stocks erased earlier losses while corporate credit, real estate and other risk assets jumped. The Fed now projects 2019 growth at 1.9%-2.2%, about 0.4% below its forecast at the last meeting. “Growth is slowing more than expected,” and “financial conditions remain less supportive of growth than in 2018,” Fed Chair Jerome Powell told a press conference after a meeting of the Federal Open Market Committee. Employment, retail sales and business fixed investment are all growing more slowly, Powell added.
The federal funds rate is now neutral, Powell added, and the FOMC believes that “we should be patient,” and that “there is no need to rush to judgment,” because it will be some time before economic conditions warrant a change in policy. The most important formal change in Fed policy is a reduction in the rate of reduction of the Fed’s $4 trillion balance sheet to just $15 billion a month starting in May, and to zero by the end of the year.
The biggest winners are carry assets – bonds, corporate credit, real estate, and mortgages. The yield on 10-year US Treasury notes dropped 0.08% to 2.535%. The largest US real estate ETF, Vanguard’s VNQ, reversed a slight loss to trade 0.75% higher after the FOMC announcement. The high yield bond ETF HYG jumped 0.5%. Major equity market indices had been down around half a percentage point, and regained the round to trade unchanged. As the chart shows, REITS and high-yield debt outperformed stocks as of 3:00 p.m. New York Times.
The big losers were bank stocks, which fell after the Fed announcement. Banks don’t like a low-interest-rate environment. Earlier in the day, FedEx lost almost 6% of its value after warning of worse-than-respected results for 2019. FedEx’s woes are yet another indication of a stressed economy. Economic reports outside of the United States continue to disappoint, notably South Korea’s February exports and Taiwan’s February exports. By all indications, world trade continues to shrink, and global capital expenditures remain on hold as corporations await the resolution –if any—of the US-China tariff war.