Weekly Market Commentary December 24, 2018

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Stock markets continued to decline last week in response to the Fed’s modest shift in its interest rate outlook. The core issues of slowing growth, how the Fed will respond, U.S. and China trade, and Brexit have introduced a high level of uncertainty in the markets.

Many investors hoped the Fed would adjust its thinking and lower future rate expectations. It did lower them, but not as much as expected, and investors expressed their disappointment. Through Thursday, the S&P sank 5.1%. Global stocks held up better as the MSCI ACWI dropped 3.8%. Concerns over economic growth have helped bonds recently, and the Bloomberg BarCap Aggregate Bond Index soared 0.5%.

Key Points for the Week (As of December 20, 2018)

  • The Federal Reserve raised interest rates by 0.25% and lowered expectations for future rate hikes.
  • The S&P 500 fell sharply as investors had expected the Fed would make a more dramatic shift in its outlook.
  • The hike marks the ninth consecutive meeting the Fed has tightened monetary policy.

Economic and Policy Update

The Federal Reserve continues to march rates higher. It unanimously voted to raise interest rates by 0.25% on Wednesday. As the accompanying chart shows, it marks the ninth consecutive meeting that included a press conference in which the Fed tightened monetary policy. Traditionally, the Fed only changes policy at the meetings that include a scheduled press conference. In eight of the last nine meetings, the Fed raised interest rates, and in one it announced it would begin reducing its balance sheet.

The increase was widely expected, and investors were primarily focused on changes to the statement that accompanies each meeting and subsequent press conference.

The Fed did not give the markets the significantly more dovish response it desired.

Its outlook did recognize the pace of rate hikes will slow in a number of ways:

  • The Fed now “judges that some further gradual increases” will occur next year. The previous language said Fed members “expect that further gradual increases” will occur, a slight moderation.
  • The number of increases expected in 2019 dropped from three to two. The range of expected interest rates lowered as some of the more hawkish members lowered their expectations.
  • The Fed also lowered its expectations for economic growth but indicated it still expects growth to hit 2.3% next year.

During the press conference, Chair Jerome Powell stuck closely to the twin objectives of the Fed: maximizing employment and stabilizing prices (inflation). Absent from that list is responding to market volatility, and the Fed did not see enough warning signs to move as far as the market desired.

The chart showing the interest rate hikes also shows the inflation level based on the Fed’s preferred measure. While the Fed was at or near its target for a number of months, the core inflation rate has recently slipped. The Fed still believes inflation will return to target given the underlying economic strength. Many investors see declining inflation as evidence the economy is beginning to slow.

Even with the adjustments, the Fed’s economic outlook remained fairly positive and did not show the same degree of concern expressed in the yield curve. The only recognition of slowing growth overseas was a sentence in the statement saying the members will monitor and assess global conditions. One presumes they do that already.

The initial reaction to the increase was negative as the Fed’s outlook for the U.S. economy and expectations for inflation remain higher than investors’ expectations. Markets had been up about 1% prior to the announcement and turned negative after the release. Thursday’s performance extended the negative trend.

We believe the Fed was correct in raising interest rates but should pay more attention to the signals market data are communicating. The reaction seems overdone, but markets are concerned about how responsive the Fed will be if the economy slows further. This week’s communication suggests the Fed will remain a source of uncertainty for the markets.

Fun Story

The True Cost of “Santa Baby”

Speaking of inflation… The song “Santa Baby” may or may not be on your list of favorite holiday songs, but it’s a regular Christmas chart topper. A writer from “The Hairpin” took it upon herself to add up all the things asked from Santa in the song, and the total is an eye-popping $1 billion-plus! And these items were priced back in 2013, so the total would only be higher today.

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