The last week’s market highlights:
Quote of the week:
“I am not afraid of storms for I am learning how to steer my ship.” – Louisa May Alcott
Each week, we present our featured topics in the context of the major themes listed below from Nuveens 2019 Outlook :
- U.S. economy: A slowdown, not a recession
- Global economy: Amid lower expectations, emerging markets could surprise to the upside
- Policy watch: Fewer tailwinds, stronger headwinds
- Fixed income: Rates likelier to rise than fall
- Equities: Late cycle but good value
- Asset allocation: A neutral stock-bond view
With no rate hike likely, why watch the Fed?
The Fed’s March 20 meeting will almost certainly be the first “live” meeting without a rate increase since September 2017. (A “live” meeting is one at which the Fed revises its public forecasts). Chair Jay Powell and other Fed officials have clearly telegraphed their intention to pause after last year’s four 25-basis-point (0.25%) hikes. Moreover, markets have priced in a near 0% chance of tightening. So what will they focus on?
- The Fed’s economic crystal ball. We think the Fed’s forecasts will reflect a slightly more cautious outlook for growth and inflation. Regarding GDP growth, a downward tweak to the previously projected 2.3% rate is possible. As for inflation, the economy shows no signs of overheating. The Consumer Price Index (CPI) slowed in January to 1.5%, the lowest year-over-year rise since September 2016. Stripping out food and energy costs, “core” CPI (2.1%) hasn’t budged in almost a year. While the Fed hasn’t significantly soured on the U.S. economy, it seems to have become far more sensitive to market moves when determining whether and how to modify rate policy.
- Connecting the dots. We’re looking for a material change to the Fed’s “dot plots.” These represent expectations for future interest-rate increases as projected by members of the Federal Open Market Committee (FOMC), the group within the Fed that sets monetary policy. In December, the median FOMC member expected two rate hikes in 2019 and one in 2020. We think at least two of those three anticipated increases will have been removed.
- Plans for keeping a larger portfolio. The Fed currently allows up to $30 billion of its holdings of U.S. Treasuries and $20 billion of mortgage-backed securities to mature each month without reinvesting the proceeds. In December, Powell stated that shrinking the Fed’s balance sheet was “on autopilot.” Since then, Fed officials have suggested otherwise, hinting heavily that they may announce a plan to end this balance sheet drawdown program soon. We expect clarity on that front.
- A higher—and lower—inflation target. The Fed may express a willingness to tolerate inflation above its 2% target under certain circumstances, knowing that inflation will inevitably fall well below that level during periods of recession or slowing growth. This shift in policy would mean that even a pickup in core inflation to 2.5%, which we view as a possibility by year end, would not necessarily be met with rate hikes.
Last but not least, Powell’s press conference may offer further clues to the Fed’s current thinking, even if this Q&A session has become less newsworthy now that one is held after every meeting. Nonetheless, it will be interesting to see the extent to which his perspective might continue to be influenced by market moves and recent rebounds in sentiment-based surveys like consumer confidence and service-sector activity. With neither the U.S.-China trade dispute nor Brexit likely to be resolved by March 20, Powell is unlikely to sound an “all clear” on global risks.
Brexit: With no agreement likely, we can barely watch
After last week’s Brexit shenanigans, things are about as clear as a foggy day in Nottinghamshire.
On March 12, the U.K. Parliament rejected the deal hammered out by Prime Minister Theresa May and the European Union (EU) for the U.K. to leave on March 29 as scheduled. While the margin of defeat (149 votes) was narrower than the 230-vote shellacking a similar proposal received in February, the outcome demonstrated just how far May has to go to amass majority support from members of Parliament (MPs).
The next day, MPs voted to rule out a “crash-out” Brexit, one in which the U.K. departs the EU without an agreement in place. This scenario is considered the most disruptive to both the U.K. and EU economies and, by extension, to global markets.
On March 14, the third day of last week’s Brexit trilogy, May notched an important win. Parliament has allowed her to ask the EU to extend the original deadline to June 30 if she’s able to push through her withdrawal plan via a third vote on March 20. May is likely hoping that enough pro-Brexit MPs who scorned her first two deals will accept this one rather than enter a period of semi-permanent limbo. And with Parliament having already voted down the possibility of a “do-over” referendum and a “soft” Brexit, pro-EU MPs might see her proposal as their best option. In effect, the prime minister may be looking to erase that 149 vote margin from both sides.
But if she fails again, European Council President Donald Tusk has announced that he’ll seek an extension of at least a year for the U.K. to “rethink its Brexit strategy” and “build consensus around it.” The other 27 EU nations must agree unanimously to his request. This means Brexit could be a long way off.
The British pound (+4.1% versus the U.S. dollar for the year to date) and U.K. stocks (+7.4% in local currency terms) have weathered the uncertainty admirably. In a dynamic reminiscent of the U.S.-China trade dispute, investors seem to believe the worst-case scenario will be averted even if they’re not terribly interested in the exact nature of the outcome. Recent U.K. economic data has also been better than expected, with the economy growing 0.5% in January, driven by upticks in manufacturing and service-sector activity.