Stocks rallied after the Fed’s dovish actions
What the Fed did at its March policy meeting (altering the dot plot to
reflect zero rate hikes in 2019 and planning to end balance-sheet
normalization in September) raised questions about just how weak global
growth must be. Fed Chair Jay Powell tried to reassure markets during his
press conference, saying that the U.S. economy is in a good place and that
the global slowdown is modest. But those comments don’t sync with the
dramatic change the Fed has made in the last few months.
We have gone from balance-sheet normalization being on auto pilot to
balance-sheet normalization being tapered and ending in a matter of months.
We have gone from talk of three rate hikes in 2019 to none. And fed funds
futures are suggesting a 60% probability of a rate cut by year-end.* Markets are now far more concerned about the growth outlook,
and that’s being reflected in Treasury yields, which are a far better fear
gauge than the VIX Index, in my view. This is creating an expectation that
other central banks may become more dovish as well.
The Fed’s dovish turn was a momentous event and should create a far more
supportive environment for risk assets. Having said that, there is clearly
some fear out there, which was reflected in Treasury yields. However, not
surprisingly, equities initially held up well, reflecting the Fed’s far
more dovish stance and the markets’ hope that Powell is not wrong when he
says that the U.S. economy is in a good place and that the global slowdown
The yield curve inverted, spooking investors
Then the yield curve inverted on Friday, March 22. The yield curve
inversion, coming quickly after the Fed’s dramatic “about face,” helped to
undermine investor confidence. That’s because investors began to question
whether the global slowdown really is a modest one. Those fears were
reinforced by weak European data and continued concerns about the
U.S.-China trade situation. I continue to believe tariffs are a
geopolitical disruption that pose a significant threat to the global
economy. There is an old saying that curses are like young chickens: they
always come home to roost. In this case, tariffs are young chickens – I
think we are beginning to see the negative effects of their roosting, with
the potential for more to come.
At the end of the day, we have to remember that an inverted yield curve
doesn’t cause a recession – but, in recent years, it has been a good
indicator that one may be coming. But there are a lot of caveats that go
along with that statement. First of all, for a yield curve inversion to be
a good predictor of a recession, it has to last about three months or more,
not a single day. And let’s not forget that there has often been a long lag
time between inversion and recession. Perhaps most important, an inverted
yield curve may just be a product of disruption created by experimental
monetary policy: major central banks have totally distorted their domestic
bond markets. There are myriad other caveats to what is a simplistic rule
of thumb. In short, I do not believe that investors should be panicking.
Rather, I believe the ensuing months could be positive ones for equities.
The Fed’s more dovish stance should be supportive for risk assets – unless
economic data deteriorates significantly.
Trump nominates a Fed critic to serve on its board
One more potential source of monetary policy disruption came last week, as
President Donald Trump nominated perennial Fed critic Stephen Moore to a
seat on the Federal Reserve Board of Governors. In the past, Moore
criticized the Fed for having an ultra-low rate policy; last year, he then
criticized the Fed for raising rates. He has even advocated for the firing
of Fed Chair Jay Powell.
I mentioned in a
recent blog post
that we could see central banks come under attack by politicians and that
we should be worried about the politicization of central banks because that
could be very disruptive and generally problematic in the next crisis.
Moore has many critics, including Greg Mankiw, a Harvard professor who was
the chair of President George W. Bush’s Council of Economic Advisers, who
has come out in opposition to Moore’s nomination. I expect some
difficulties with a Senate confirmation. We will want to follow this
It’s commonly said that the definition of insanity is doing the same thing
over and over again, but expecting a different outcome. I can’t help but
think of that definition as I watch U.K. Prime Minister Theresa May attempt
to hold a third vote on her Brexit plan this week. May pulled off a
nail-biter last week, securing a Brexit extension beyond March 29 from the
European Union, with the length of the extension dependent on what happens
May plans on holding a third vote in Parliament on her plan, although House
of Commons Speaker John Bercow has already announced it will have to be
significantly different from the previous Brexit plans in order for him to
allow the vote. From my perspective, it seems increasingly likely that the
U.K. will hold another referendum on Brexit, but anything is clearly
possible. The good news is that a “crash out” has been averted – at least
for the time being.
* Source: CME FedWatch Tool
is Global Market Strategist at Invesco. This article first appeared in
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The yield curve plots interest rates, at a set point in time, of bonds
having equal credit quality but differing maturity dates to project future
interest rate changes and economic activity. An inverted yield curve is one
in which shorter-term bonds have a higher yield than longer-term bonds of
the same credit quality. In a normal yield curve, longer-term bonds have a
Gross domestic product is a broad indicator of a region’s economic
activity, measuring the monetary value of all the finished goods and
services produced in that region over a specified period of time.
The CME FedWatch Tool analyzes the probability of upcoming Fed rate moves,
using 30-day fed fund futures pricing data. Fed funds futures are financial
contracts that represent the market’s opinion of where the fed funds rate
will be at a specified point in the future.
The CBOE Volatility Index® (VIX®) is a key measure of market expectations
of near-term volatility conveyed by S&P 500 stock index option prices.
VIX is the ticker symbol for the Chicago Board Options Exchange (CBOE)
Volatility Index, which shows the market’s expectation of 30-day
The opinions referenced above are those of Kristina Hooper as at March 25,
2019. These comments should not be construed as recommendations, but as an
illustration of broader themes. Forward-looking statements are not
guarantees of future results. They involve risks, uncertainties and
assumptions; there can be no assurance that actual results will not differ
materially from expectations.
This does not constitute a recommendation of any investment strategy or
product for a particular investor. Investors should consult a financial
advisor/financial consultant before making any investment decisions.
Invesco does not provide tax advice. The tax information contained herein
is general and is not exhaustive by nature. Federal and provincial tax laws
are complex and constantly changing. Investors should always consult their
own legal or tax professional for information concerning their individual
situation. The opinions expressed are those of the authors, are based on
current market conditions and are subject to change without notice. These
opinions may differ from those of other Invesco investment professionals.
© 2019 by Invesco Canada Ltd. Reprinted with permission.