The Market Today
Brexit Chaos and Fed’s About-Face Battle for Investors’ Attention
by Craig Dismuke, Dudley Carter
Philadelphia Fed Survey Shows Mixed Details While Jobless Claims Remain Strong: The Philadelphia Fed’s business outlook index bounced back more than expected in March from almost a three-year low the month before, but held below levels seen throughout most of the prior two years. In addition, the details were mixed as weaker employment offset stronger new orders and shipments. Also reflecting continued uncertainty, overall expectations for six months from now dropped notably to the weakest level in three years.
Jobless claims, however, continue to reflect strength in the U.S. labor market which should keep consumer expectations buoyed despite some uncertainty in recent spending data. Initial jobless claims fell 9k in the week ended March 16, the reference week for March’s nonfarm payroll report, to a better-than-expected 221k, a four-week low. However, dropping an even stronger 217k from the calculation nudged the four-week average up 1k to a still solid 225k. Continued low claims data will strengthen those who believe February’s payroll disappointment was a give-back from a surge in hiring in January, and suspect the three month-average of 186k payroll gains is more indicative of the underlying trend in the labor market.
Yesterday – Fed’s Dovish Decision Sent Rates Spiraling: U.S. equities ended lower Wednesday as investors dealt with headlines from multiple fronts, including a more-dovish-than-expected decision from the Federal Reserve. Shares of FedEx opened down more than 6% after the company cut its full-year forecast again as a result of sundry headwinds, including a slowing global economy and slower world trade amid “heightened uncertainty.” Trade headlines took another bite out of equity valuations around 11:30 CT, as the Dow quickly fell to new lows on a comment from President Trump that a trade deal with China is “coming along nicely” but existing tariffs may remain in place for “a substantial period of time” as an enforcement mechanism. However, the sharpest price action came after the Fed’s unequivocally dovish decision (more below), which included a shift from two expected rate increases in 2019 to none. Stocks surged and Treasury yields sank. The 2-year Treasury yield fell 7.2 bps to 2.40% as the Fed Funds futures curve flattened notably lower. The futures market ended pricing in an effective rate of 2.285% for January 2020, implying a roughly 50% chance of a rate cut by then. Adjustments were even more severe further out, with the 5-year yield falling 9.8 bps to 2.33%, below the effective Fed Funds rate of 2.40% and the lowest level since January 2018. The 2-, 3-, 5-, and 7-year notes also closed within the Fed’s current target range (2.25%-2.50%). The 10-year yield fell 8.6 bps to 2.53%, also a new low since January 2018, flattening the curve to 12 bps between 2s and 10s. Despite the initial surge for equities, losses for financial companies intensified as rates sank, ultimately pulling the Dow and S&P 500 back into negative territory for the day. S&P 500 financials fell 2.1% to lead the S&P 500 down 0.3% on the day.
Overnight – Brexit Chaos and Fed’s Dovish About-Face Battle for Investors’ Attention: Brexit remains a major focus for global investors but yesterday’s Fed announcement is likely to absorb the lion’s share of time spent Thursday around global water coolers outside of the UK. Chaos has ensued in the UK as next week’s deadline to reach a deal, gain an extension, or crash out of the EU creeps ever closer. PM May was barred by the House Speaker from bringing her plan up for a third vote this week unless it had changed significantly, leading her to request an extension from the EU until June 30. The EU has been less than eager to grant the short extension absent Parliament’s backing of the current deal. Some seem more open to a longer extension, which PM May indicated could lead to her resignation, result in a complete rewrite of the deal, or even a second Brexit referendum. The continued chaos has pushed the Pound down another 0.6% overnight, kept the BoE on the sidelines for another meeting, but didn’t disrupt consumer spending in February; monthly retail sales topped estimates. But maybe more important Thursday to global markets outside of the UK, was yesterday’s dovish Fed turn. The Fed’s drastic downshift in the dots sent Treasury yields tumbling and, after a brief initial bounce, pushed equities lower as investors remembered the reason for the change was a tenuous economic outlook. A similar response has been reflected in global markets as equities treaded water and sovereign yields moved down. The German 10-year yield was 4.1 bps lower earlier, one of the smaller moves on the day, to 0.04%, the lowest level since September 2016. U.S. equity futures have retreated further and Treasury yields ticked down as much as 2 bps overnight.
FOMC’s Newfound Patience Pervades the March Decision: As expected, the Fed left the target range at 2.25% to 2.50%, lowered the dots, softened the Statement’s economic assessment, and announced an end date to balance sheet normalization. However, the degree of the shift was exceptionally dovish. The Statement acknowledged “economic activity has slowed from its solid rate in the fourth quarter,” because of weaker household and business spending. But the most notable shift was in the dot plot, which is now better aligned with the neutral bias adopted in January’s Statement. The median Fed official now expects no rate increases in 2019, down from two in December’s forecast and an even greater concession from the three hikes penciled in back in September. In fact, 11 officials coalesced around March’s call for no 2019 rate hikes compared with just two back in December (four removed one rate hike, five removed two). By a margin of two officials, one rate hike is still expected in 2020 placing the terminal Fed Funds range at 2.50% to 2.75%, implying a midpoint below the longer run neutral rate of 2.75%; quite the change from the prior forecast for a top range of 3.00% to 3.25% and restrictive policy in 2019, 2020, and 2021 (see chart of the day). Elsewhere in the projections, the growth estimate for 2019 was dropped 0.2% to 2.1% and for 2020 was lowered by 0.1% to 1.9% while unemployment estimates for the two years were nudged up 0.2% to 3.7% and 3.8%, respectively. The estimate for 2021 was also increased by 0.1% to 3.9% while the natural rate was dropped 0.1% to 4.3%. Core PCE inflation was kept flat at 2.0% through 2021.
In a separate release alongside the Statement, the Fed announced it will lower the cap on Treasury roll-off from $30B to $15B in May and conclude the reduction of its overall portfolio at the end of September. Starting in October, the first $20B of cash receipts from its agency-related portfolio holdings will be reinvested into Treasurys, with any in excess of that threshold reinvested back into agency mortgage backed securities. The current maturity composition of the portfolio will be used as a guide for reinvestments with continued future conversations planned to determine the ultimate structure of its holdings.
While he contended the outlook remains positive, Chair Powell did not try to soften the tone of the official reports in his press conference remarks. He said the most recent economic data is not signaling that the Fed needs to move interest rates in one direction or another, ”Which is really why we’re being patient. We feel our policy rate is in the range of neutral. The economy is growing at about trend. Inflation’s close to target. Unemployment is under 3% (sic). It’s a great time for us to be patient and watch and wait and see how things evolve.” Bottom Line: The Fed’s recent language has signaled they would remain patient in determining their next move to allow for more clarity on the outlook amid increased uncertainties (e.g. slower global and domestic growth, U.S.-China trade negotiations, Brexit, lagged effects of prior tightening). The March decision exceeded the market’s expectation in backing that up and addresses a major area of concern, that of a monetary policy error, for investors.