Janus Henderson: Markets don’t like what they are Fed

The US Federal Reserve (Fed) is in a difficult position. Investors appear to have real concerns about an approaching US recession despite consensus forecasts for solid growth over the next two years. Normally, this would suggest that the market expects lower interest rates. However, for the Fed to cut interest rates, it would need to admit that the economy is rolling over – this is contradictory to their own forecasts. In particular, the Fed would need to move away from its data-driven concerns about future inflation due to a tight labour market, which have been the driver of recent hikes. Doing so would risk spooking investors by confirming their worst fears. It is therefore difficult to see exactly what the Fed could have said that would have satisfied skittish markets. The focus on the real economy rather than financial assets appears the right one to us, even as growth looks set to moderate in the US.

The language from the Fed was moderated in line with recent statements from Fed Chair, Jerome Powell, and there was acknowledgement of the wider, global economic risks. The number of interest rate increases for 2019 was reduced to just two, from three. Importantly for US bonds markets, the longer-term expected interest rate was reduced by a quarter of a percent to 2.75%. This is now the level at which the 10-year US Treasury yield sits this morning, showing how closely the market pays attention to the utterances of the world’s pre-eminent central bank.

There were a lot of pressures on the Fed going into the meeting: President Trump had been vocal about his opposition to an interest rate increase, equity markets had fallen sharply and markets were getting close to ruling out any interest rate increases in 2019. In the end, Chair Powell has perhaps shed some of his ‘markets guy’ image, in favour of the real economy. US economic growth is expected to moderate but, like the Fed, we do not yet see signs that a recession is imminent. Slower interest rate rises may take some of the steam out of the US dollar rally, easing financial conditions for those in the rest of the world that are dependent on the greenback for funding, such as emerging markets.