ETFWorld.co.uk

WisdomTree : Fed Watch – Some Like It Hot

WisdomTree Fed

WisdomTree: Certainly, no one can argue that the shift in the Federal Reserve’s (Fed’s) monetary policy outlook has been perhaps the most noteworthy development that has occurred in the money and bond markets thus far in 2019. ..

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By Kevin Flanagan, Head of Fixed Income Strategy


The problem is this shift has only created an extra layer of uncertainty in the rate outlook. Ah, remember the good old days (last year) when the Fed would telegraph their moves. Well, that’s all changed now.

So, while the debate for 2019 and 2020 seems to have gravitated to when the Fed would actually cut rates, I offer a different take. What if the Federal Open Market Committee (FOMC) goes on a ‘policy sabbatical’ of sorts, and just leaves well enough alone? In other words, just sit back and let the economy ‘run hot’.

The results of this week’s FOMC meeting plays into my line of reasoning.

Indeed, the policymakers continue to see the economy in reasonably good shape, but the deceleration in core inflation holds the key to my argument.

There is no urgency to cut rates or raise them for that matter. Thus, why mess with a good thing, right?

And don’t forget, the Fed will be ending their quantitative tightening of the balance sheet at the end of September.

Against this backdrop, it falls on Fed Chairman Powell & Co. to potentially shift the market’s mindset from the rate cut mentality.

Let’s face it, the rate hike aspect was discarded months ago. Heading into the May 1st FOMC meeting, the fed funds futures market was, once again, pricing in a rate cut for this year, and two additional easing moves for 2020. I don’t think the Fed is quite there in their own policy outlook. So, the disconnect continues.

It would seem that despite the much better than expected headline reading for Q1 real GDP (+3.2%), the market has shifted its own reasoning away from a meaningful growth slowdown/potential recession outlook more to the inflation side of the equation.

Sure, inventories and trade provided the boost for Q1 growth and can easily be reversed in the coming months, but it appears as if inflation is the market’s new obsession.

The latest data continues to show the Fed’s preferred core measure, Personal Consumption Expenditures (PCE) deflator, still residing visibly below the +2% target at +1.6%.

Conclusion

If I’m right and the Fed is in an elongated pause mode, the Treasury market is going to have to come to terms with the potential for economic growth running a bit ‘hotter’ than one would have originally thought.

How does, say, the UST 10-year yield respond to this newfound policy environment?

Probably just continuing on its merry, range-bound way, until the time comes when all of a sudden investors could wake up one day and wonder: is the Fed now behind the curve?

Source: ETFWorld.co.uk