US Fed keeps interest rate unchanged, says it will be 'patient'

Anna Jefferson
February 2, 2019

U.S. investors have failed to understand what the Fed's change means (and we are now seeing it in some 4th quarter financial reports) for share prices - the economy is slowing and so might earnings.

On Wednesday he again confirmed expectations that the central bank had softened its stance and messaging, leaving rates on hold at 2.5 per cent.

Winding back the size of its balance sheet is a tightening of monetary policy which has spooked Wall Street previously - the so-called taper tantrums as we saw in 2013 and 2015 saw sharp sell-offs and a rise in market volatility, as we saw in November and December a year ago.

The FOMC increased the benchmark rate four times past year but rising concerns about a slowing U.S. economy amid a trade war with China prompted officials to signal they would take time to gauge the economy's performance.

For the S&P 500, it was the biggest one-day gain on the final day of a Fed meeting since December 2014, according to Dow Jones Market Data. Despite this, Trump made a decision to cash in on the good news by tweeting, "Dow just broke 25,000", he tweeted after the Dow closed up 435 points.

On the balance sheetsource June 2: The Eccles Building, location of the Board of Governors of the Federal Reserve System and of the Federal Open Market Committee, June 2, 2016 in Washington, DC. "We have the luxury to be patient". The Fed's preferred inflation gauge has risen 1.8 percent in the past 12 months, below its 2 percent annual target. "I would want to see a need for further rate increases, and for me, a big part of that would be inflation, " he said. "Higher beta FX outperformed, likely reflecting the expectation that the Fed will err on the side of running the economy hot". But at some point, to avoid weakening the economy, it could slow that process or end it sooner than envisioned.

In a separate statement, the Fed also said that it would continue to normalize its balance sheet, but was prepared to alter details of the program "in light of economic and financial developments".

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Another sign of waning prospects for a rate hike this year was the drop in near-dated implied volatility on swaptions - options on US interest-rate swaps - which dropped to the lowest since November for one- to two-year contracts.

Market professionals have spotted an explanatory vacuum, and they're rushing to fill it.

Bostjancic suggested that Powell wants to convey that he is mindful of the economic risks that are worrying investors, including weakening global growth, the USA trade war with China and Britain's struggles to achieve a smooth exit from the European Union.

The message delivered by the Fed "just couldn't be much better for both bonds and equities and for the credit markets that track Treasurys", said Mark Grant, chief global strategist at B. Riley FBR, in a note.

However, Mr Powell cautioned that another shutdown or protracted trade negotiations with China could hurt the economy by sapping business confidence.

Yesterday's ADP employment report showed us that we created 213k jobs in Jan vs. the expected 181k jobs while wages and unemployment held steady - and that continues to suggest it is a robust environment in the US. And corporate earnings have so far been holding up in the face of the global slowdown and trade conflicts.

The German government has cut its forecast for growth for 2019 to 1 percent from 1.8 percent, citing growing geopolitical and trade risks.

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The Fed's statement on Wednesday contained the two things investors most wanted to hear: that the central bank would be "patient" on future rate hikes, and that it would be flexible when it came to its balance sheet. And it did so even though it still believes 2019 will see solid economic growth, a strong jobs market and inflation near its goal.

"Remarkably", she said, the dovish guidance and the Fed's change of vocabulary - "adjustments" to the target range for the federal funds rate has replaced "increases" - puts "interest rate cuts back on the table".

This decision by the Fed was large what Wall Street expected, and the Street reacted favorably with a welcome surge in stocks.

The assurances from the central bank have helped allay fears that higher borrowing costs might depress corporate earnings and economic growth.

In recent weeks, however, the Fed has been hamstrung in its effort to assess the health of the economy.

A second shutdown could have "a permanent effect or lasting effect", he said.

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