Rates cut again — What is the Fed trying to tell us?
What did the Fed do?
On September 18, the Federal Reserve made three decisions that are relevant for investors:
- The Fed lowered interest rates by 0.25%, to a range of 1.75% – 2.00%. The Fed expects the U.S. expansion to continue but wants to cushion the economy against downside risks.
- The Fed revised down its expectations for interest rates over the next three years. It still expects rates to hover near 2.5% in the long term.
Implied Fed Funds Target Rate
- The Fed made– and signaled – some tweaks regarding its support of money markets. This is mostly a technical adjustment, but it helps the Fed to improve its support of market liquidity in the event of a future panic.
Monetary policy has moved from “sure thing” to “big risk.”
Central banks have moved more supportive of the global economy in recent months. They’ve also been a bit easier to predict; investors have received the news they expected – or in some cases even more dovish – which is supportive of financial markets.
The path from here is less certain. In the U.S., the market expects at least one more rate cut this year, with another in early 2020. Without a further deterioration in the U.S. economy, Fed Chair Jay Powell may not have the consensus to be as aggressive as the market expects. This could create room for disappointment, particularly in equity markets where valuations have relied heavily on lower interest rate expectations.
What does this mean for investors?
These moves were widely expected, so we should see minimal or slightly positive market reaction in response to the Fed’s decisions, all else being equal.
For most investors, today’s interest rate policy change should not impact their investment mix. Instead, investors should consider how the move fits into the Fed’s policy trajectory and broader economic outlook. Here we have two key takeaways:
- Stay invested. The U.S. consumer remains robust, and the Federal Reserve is stepping in to support the economy against risks. It is too early for investors to run for the hills.
- Be cautious. The economy is late in its cycle, valuations are high, and risks are strong. We are moving gradually more cautious in our portfolios focusing on generating income and diversifying our exposures.
What is next?
In recent weeks, market movement has correlated with higher expectations for global economic growth. Bond yields have risen, and cyclical sectors have outperformed. We think it is too early to take this approach. In the absence of a catalyst for economic growth, such as a reliable trade truce or further fiscal stimulus, slowing economic growth and heavily weighted risks will likely dominate market sentiment through the end of the year.
This material represents an assessment of the market environment as at a specific date; is subject to change; and is not intended to be a forecast of future events or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding the funds or any issuer or security in particular.
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