The past week’s market highlights:
Quote of the week:
“We lost because we didn't win." – Ronaldo, after Brazil’s 3-0 loss to France in the 1998 World Cup final
Each week, we present our featured topics in the context of the major themes listed below from the Nuveen Q2 Outlook:
- U.S. economy: Late cycle has arrived.
- Global economy: There’s still good news out there.
- Policy watch: In an unusual twist, U.S. fiscal and monetary policies are diverging.
- Fixed income: Bond markets offer few places to run, even fewer places to hide.
- Equities: The bull market’s not over, but expect plenty more volatility.
- Asset allocation: Valuations are no longer at extremes.
Policy watch: Central banks are operating at two different speeds
To no one’s surprise, the June 13 meeting of the Federal Open Market Committee— the group within the Federal Reserve that sets monetary policy—ended with a 25-basis-point (0.25%) increase in the federal funds rate, to a target range of 1.75%-2.00%. This move marked the seventh hike of the Fed’s current tightening cycle and the second in 2018. Officials now anticipate a total of four hikes this year, up from three at the March meeting, plus another three next year. We agree, calling for two 25-basis-point increases (one each at the September and December 2018 meetings).
Purposely steering clear of economic jargon in his upbeat post-meeting press conference, Fed Chair Jerome Powell declared that “the economy is in great shape” and “people who want to find jobs are finding them.” While he raised no red flags about the economy, Powell noted that unpredictable U.S. trade policy could depress business confidence. At the same time, he stated that officials have yet to detect ill effects in the economic data tracked by the Fed.
Powell also announced that, starting in January 2019, he will conduct a Q&A after every Fed meeting—not just those at which rate decisions or other policy actions are announced. (Markets have come to expect no policy announcements at the four meetings per year that aren’t followed by a planned press conference.) He made clear that this decision has no bearing on interest-rate policy but instead represents a desire to improve communication with financial markets.
Fixed-income markets have largely priced in the Fed’s anticipated pace of quarterly rate hikes. Nonetheless, fed funds futures still have some catching up to do. The probability of the Fed increasing interest rates in September and December jumped this week to 80% and 62%, respectively. Meanwhile, the odds of a March 2019 hike are only a tossup. At its currently projected pace, the Fed will reach its own definition of a “neutral” target rate—one that neither accelerates nor restrains the economy—of approximately 2.9% by this time next year.
(For more information on our view of the Federal Reserve’s June meeting, see "The Fed's June meeting: Hikes continue amid geopolitical noise.")
The Fed’s pivot from quantitative easing (QE) to policy tightening occurred over a period between May 2013 and December 2015, generally without incident. In the Eurozone, though, the prospect of a similar shift has been a source of uncertainty and concern. Thankfully, on June 14 the European Central Bank (ECB) provided some clarity. After September 2018, the ECB plans to reduce its monthly asset purchases, from €30 billion to €15 billion per month. Then, in December 2018, the ECB will stop buying bonds altogether. Lastly, in a bold move, the ECB pledged to delay raising interest rates until after the summer of 2019, at the earliest. This should help ensure that financial conditions in Europe don’t tighten excessively.
ECB President Mario Draghi seems to be hewing to the Fed’s successful strategy of postponing rate hikes until well after QE has ended. (The Fed didn’t start raising interest rates until December 2015, more than a year after it had concluded tapering its QE purchases.) The ECB’s “pause pledge” has contributed to further weakening of the euro—a welcome development for the continent’s exporters—and could reinflate some of the confidence meters that have been flagging in recent months.
We doubt Eurozone inflation will approach the ECB’s 2% target by the middle of 2019, the earliest scheduled starting point for its rate hikes to begin. Consequently, we’d prefer to see the ECB pause even longer—perhaps into 2020—before it takes action. But with Draghi set to step down as president in the fall of 2019, and with Germany clamoring for the “easy money” era to end, Europe could get a rate hike sooner than that—and sooner than it needs to, in our view.