More Candy, Please!
August 1, 2019
Did the Fed's Rate Cut Satisfy Investors' Sweet Tooth for More Easing? Informational commentary from Pacific Asset Management, manager of Pacific Funds Fixed-Income Funds.
- The Federal Open Market Committee (FOMC) lowered the federal funds target rate range by 25 basis points to 2% to 2.25%, its first rate cut since 2008.
- Language changes were minor, but emphasized the committee was easing policy "in light of global developments for the economic outlook as well as muted inflation pressures."
- The Federal Reserve (Fed) also left the door open to future cuts, starting it will "act as appropriate to sustain the expansion."
- Balance-sheet reduction is expected to end two months earlier than planned.
Even though lowering rates, addressing global uncertainty, leaving open the possibility of future cuts, and ending the balance sheet runoff early are all dovish, the markets did not react well to Federal Reserve Chairman Jerome Powell’s statement that this was a “mid-cycle adjustment.” The Dow Jones Industrial Index ended the day down 333 points and the odds of future cuts in September and December had lowered. Below are the Fed’s language changes followed by our brief thoughts:
The quarter-point rate cut was widely expected, but Chairman Powell’s mention of this being a “mid-cycle adjustment” left markets wanting more accommodation. Many investors hoped this rate cut would be framed as the start of a more aggressive easing cycle. Prior to the meeting, the probability of a second 25 basis point rate cut in September sat at 76%, while the chance of a third cut in December was 56%. But after this week’s action, there is now a 67% chance of a second 25 basis point rate cut in September and a 50% chance of a third 25 basis point cut in December.(1)
Overall, we believe the Fed’s move was prudent. If the Fed didn’t cut rates, it would have been perceived as too hawkish and resulted in a contraction of risk, while a 50 basis point rate cut could have resulted in further leverage and asset price distortions.
While these decisions are technically “on the margin,” the Fed must balance an economy with low unemployment, increased deficit spending, equity markets at all-time highs, and a low default environment with slowing growth data, a strong dollar, trade tensions, and low inflation. At this point, it seems monetary policy plays a greater role in asset prices than economic growth. While the “wealth effect” is generally good for risk, it can lead to unhealthy price distortions and overly aggressive borrowing.
Throughout this economic expansion, the longest in U.S. history, markets have repeatedly asked for, and received, liquidity “candy” from the Fed. When the Fed took away more than we expected in the fourth quarter of 2018, investors of all types threw a tantrum. While the Fed gave investors some candy this week, it indicated that there may be no more sweets for some time. Once again, investors threw a little tantrum. It is unclear how much candy investors are hoping for in 2019, but a healthier market requires different nutrition.
(1) Source: Bloomberg Finance L.P., 7/31/19.
This publication is provided by Pacific Funds. Pacific Funds refers to Pacific Funds Series Trust. This commentary reflects the views of the portfolio managers at Pacific Asset Management as of August 1, 2019, are based on current market conditions, and are subject to change without notice. These views represent the opinions of the portfolio managers and are presented for informational purposes only. These views should not be construed as investment advice, an endorsement of any security, mutual fund, sector, or index, the offer or sale of any investment, or to predict performance of any investment. Any forward-looking statements are not guaranteed. All materials are compiled from sources believed to be reliable, but accuracy cannot be guaranteed.
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