Is The Fed Steering Us to Recession in 2019 or a Soft Landing?
December 17, 2018
By Michael List, CFP
The Federal Reserve (Fed or FOMC) is a nonpartisan part of government with a dual mandate to promote full employment and stable pricing. But, it has a shaky record. According to many experts, The Fed has influenced or triggered 5 of the last 7 recessions. While the current rate hike cycle has been much slower and lower than past ones, market participants are beginning to wonder where the Fed is leading us this time.
Are The Fed and the Markets On The Same Page?
This week, the market will be listening closely to the Fed’s tone and expectations about rate increases in 2019.Two weeks ago, my colleague Michelle Holmes highlighted the change in Chairperson Powell's tone regarding the neutral rate. At the last FOMC meeting, Fed members were projecting four hikes by the end of 2019. But over the last month, market expectations have shifted, now anticipating slightly more than one hike through the end of next year.
If the Fed’s expectations don’t change, there will be a stark difference between the projections of the market and FOMC members as we roll into 2019. And, keep in mind — FOMC members are the only ones who vote.
Why The Fed Should Remain Neutral in 2019
The yield curve has flattened dramatically this year (2 to 5-year Treasuries recently inverted), as you can see from the chart above. The inversion you see in the intermediate part of the curve is the tension between market and Fed expectations. Recent economic data is pointing to slower growth in the coming quarters. With this in mind, there appears to be no compelling reason to move rates substantially higher today.
Gross Domestic Product (GDP) grew at 3.5 percent and 4.2 percent during the past two quarters and the unemployment rate remained steady at 3.7 percent. Both of these exceed the Fed’s long-term projections of 1.8 percent GDP growth and 4.5 percent unemployment. However, inflation has recently fallen below the Fed’s target — and that doesn't even account for the huge drop in oil this quarter.
So yes, the economy no longer needs ultra-easy accommodative life support from the Fed. But intentionally taking rates above neutral, with no indication of runaway inflation, does not seem appropriate either. We hope the market doesn’t look at the Fed next June and wonder — to quote Lloyd Christmas in one of the best holiday movies ever made — “Do you REALIZE WHAT YOU’VE DONE?!"
“Don't fight the Fed.”
There is an old Wall Street saying that fits very well: “Don’t fight the Fed." Today, however, the bond market is clearly at odds with the Fed.
Like everyone else, we have opinions about what the Fed should do and what they are likely to do, but we try to balance our expectations with this ancient wisdom by asking ourselves, “What if we are wrong?” That is why we have positioned our fixed income defensively, focused on quality and shorter duration. This has allowed portfolios to generate more income as interest rates rise, without taking on the interest rate risk of long-term bonds.
If you would like to find out more about how you are positioned going into 2019, we can help. Set up a meeting with a Wealth Management advisor today.