Doves Fly As Fed Keeps Rates Unchanged, Signals Easy Policy For Rest Of Year

(Wednesday Post-Fed) If anyone was losing sleep about the prospect of the Fed getting more hawkish in coming months, it looks like they might be able to grab some shut-eye. Today, citing slowing economic growth, the Fed held rates steady and sent strong signals that there might be no more rate hikes at all this year.

Going into the meeting, many investors had been thinking the Fed might have another 2019 hike in its pocket, but this brings that into question. The Fed’s dovishness today was more pronounced than we’ve seen in the recent past, and that appeared to send stocks higher and Treasury yields lower in the immediate wake of the decision. The dollar, meanwhile, tumbled to a six-week low.

Most Fed officials whose estimates appeared in a new “dot plot” projecting future rates forecast no increase in 2019. The Fed also reduced its expectations for U.S. economic growth and inflation and raised its projection for unemployment. None of this would appear too surprising, judging from comments Fed Chair Jerome Powell and other Fed officials have made recently about the slowing economy, and from the latest set of benign inflation data.

Though stocks initially reacted positively to the Fed announcement, it’s not necessarily positive for the economy to see the Fed cut its GDP estimate for 2019 to 2.1% from 2.3%. It also trimmed its Personal Consumption Expenditures (PCE) inflation forecast to 1.8% from 1.9%.

The Fed said economic growth has “slowed” from Q4, and that job growth has been “solid.” It previously had called job growth “strong.”

“Recent indicators point to slower growth of household spending and business fixed investment in the first quarter,” the Fed said in updated language from the previous statement.

This might square with news that just came out this morning, when FedEx Corporation (NYSE:FDX) reported weaker-than-expected earnings and sales, while reducing guidance as it cited a weak international trade situation (see more below). Seeing the Fed drop its productivity estimate for the U.S. even as FDX and other companies report troubles in their international markets seems to tie many of today’s stories together, especially how the trade battle with China might be hurting the economy.

In another move likely to get a close look from many investors, the Fed said it plans to start tapering its balance-sheet runoff in May, ending in September. That’s probably not a surprise, because the Fed foreshadowed this with comments members made in recent speeches. By slowing and then ending the balance-sheet reduction, the Fed could be hoping to give the economy a little stimulus without taking the more dramatic step of lowering rates.

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However, it doesn’t look like all the investors out there necessarily agree that adjusting its balance sheet strategy will provide the Fed enough ammunition as the economy slows. Chances of a Fed rate cut by the end of the year quickly climbed to above 35% after the Fed decision, according to the CME futures market. The odds had been around 22% earlier this week.

Along with its statement, the Fed issued an updated “dot plot” showing where Fed officials see rates going in coming years.

What might have been surprising was the Fed’s forecast not only for no change in rates this year, but for rates to be 50 basis points lower by the end of 2020 than it had forecast just three months ago. Back in December, the Fed had forecast rates to be in a range between 2.9% and 3.4% by the end of next year. Now the range is 2.4% to 2.9%.

Looking at the last dot plot vs. the new one side by side, it seems pretty striking how estimates have come down. That’s especially true for next year, which looks far less hawkish than expectations a few months ago.

In his post-meeting press conference, Powell said weakening economies in Europe and Asia are weighing on the U.S. economy.

Stocks have been on a tear thanks in part to the Fed’s desire to stay “patient” and watch the data come in. At the same time, U.S. benchmark 10-year Treasury yields traded near two-month lows below 2.59% before the Fed’s decision Wednesday. Rates have fallen from above 3.2% last fall as investors factor out chances of more Fed rate hikes and as the global economy slows. Weakness from China and Europe might both be factoring into the lower borrowing costs.

One thing investors might want to consider keeping in mind as they pore over the Fed’s statement and check in on Powell’s press conference is for any hint of where the Fed now sees the so-called “neutral” short-term rate. That’s the level where the Fed believes rates aren’t too tight or too loose. In December, this level ranged between 2.5% and 3.5%, according to Fed officials. The Fed’s benchmark rate now is between 2.25% and 2.5%. If the neutral level comes down, The Wall Street Journal noted, that could imply that the Fed sees less need for future rate hikes.

Before the Fed decision Wednesday, U.S. stock indices took a dive as concerns grew over the tariff situation. This seemed to be driven by comments made by President Trump and reported by several media outlets that he’s prepared to leave tariffs in place on Chinese goods for a “substantial amount of time.”

According to The Wall Street Journal, Trump said he isn’t considering removing the tariffs on China because he wants to make sure China “lives by the deal.” Before today, there was hope that a deal might mean an end or at least a cut in U.S. and Chinese tariffs on each others’ goods.

The U.S. has levied tariffs on $250 billion of Chinese goods, about half the value of all Chinese exports to the U.S. Beijing has retaliated with tariffs on $110 billion of U.S. goods, about 90% of what the U.S. exports to China. After Trump’s words, shares of some China-sensitive stocks like Caterpillar (NYSE:CAT) and Deere (NYSE:DE) both fell, and semiconductors—another area with wide exposure to China—also weakened.

The rough patch for Wall Street before the Fed decision accompanied both Trump’s latest words and a media report yesterday questioning progress in the negotiations. It looks like the market remains on tenterhooks regarding trade, and the FedEx (FDX) earnings this morning where the company talked about a soft international trade situation appeared to add to investors’ jitters.

Stocks and Treasuries have both been steadily climbing. That’s kind of an unusual situation. 10-year yields are at two-month lows below 2.6%, while stocks surged back from early weakness Wednesday after the Fed decision.