Fed Folds

Whilst no one was expecting the Fed to do anything other than hold rates last night they surprised the market with considerably more dovish forward guidance on the back of another downgrade to their economic outlook for the US.

The Fed kept rates at 2.25% but said there will be no hikes in 2019 and only one in 2020.  That is a big correction, taking their median funds rate from 2.9% to 2.4% this year and from 3.1% in each of 2020 and 2021 to 2.6% for both.  Their QE amassed balance sheet unwind will taper and finish earlier in September also.

On that simple “cheap money” headline US shares surged after having been battered by Trump announcing China tariffs would stay in place until China come to the party on a deal.  But then the reality of WHY the Fed was pausing hit home.  In announcing its rate guidance the Fed downgraded growth forecasts saying economic activity has slowed from the solid Q4 rate.  It downgraded 2019 GDP to 2.1% (from 2.3%), 2020 GDP to 1.9% (from 2%) and kept 2021 at just 1.8%.  Likewise they increased unemployment for each year and also cut their inflation forecasts to 1.8%, 2.0% and 2.0% respectively.  In other words the reason for the dovish change is the economy is deteriorating.  Accordingly shares and the USD tanked and gold jumped to hit USD1316.

Should the scenario painted by the Fed of a year of holding rates after having raised them over the preceding quarter and then raising again play out, it would be unprecedented.  Accordingly to Bloomberg, there have only been 3 instances of this and each was followed by a rate cut to ward off a recession, not a rate hike after that year.  You may remember these years well.  They were 1997, 2000 and 2006…

In lockstep with shares down and gold up, US Treasury yields tumbled too, with the 10 year at levels seen in 2 year notes just 2 weeks ago and the inevitable flow through to a 3m10yr yield curve getting closer and closer to inversion.