(23 FEBRUARY 2019)WEEKLY MARKET OUTLOOK 2:The Fed’s Triple Mandate
Last week’s main event was the publication of January’s FOMC meeting minutes. Even though the release was anxiously awaited, investors’ reaction was quite muted. Equities across the globe edged slightly higher as the minutes showed that Fed members started discussing the end of quantitative tightening (already). Overall, the minutes didn’t bring much new information to the table: Fed members are worried about a slowing economy, not only in China but in general, and are concerned that too much tightening could derail the current dynamic. However, market participants were expecting much more dovish minutes after the Fed dropped the “gradual increases” [in interest rates] reference from the statement. In fact, the minutes suggest that the Fed is leaving the door open for further increase this year. It is therefore a small bias towards tightening. The main surprise was a much more dovish stance regarding the balance sheet reduction. Indeed, over the last few months, the Fed’s communication suggested that the unwinding process would last until the balance sheet reached a more reasonable level (around $1.5tn and $2.5tn). Nevertheless, according to the minutes, the Fed is now considering backing off before the end of the year; or at least provide a plan to stop reducing before the end of the year. Investors knew the balance sheet would not return to pre-crisis levels but they were expecting a much smaller one (i.e. smaller than $3tn). This raises the question of what tricks the Fed will use in case of a crisis. Indeed, with already low interest rates and a gigantic balance sheet, what tools can be used to soften the next economic crisis ?
Regarding the economic outlook, the Committee maintained its optimistic view, saying that “participants continued to view a sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee’s symmetric 2 percent objective as the most likely outcomes over the next few years.” They acknowledge that the economic expansion may slowdown in 2019 but there was no mention of a potential recession. On a side note – In our opinion, it is very interesting to note that despite the fact that Fed members have maintained a positive bias regarding the economic outlook, they are slowly but surely moving away from tightening. This is definitely not the kind of reaction we would expect during periods of economic expansion. It therefore looks like the Fed is more concerns about a market correction.
BY Arnaud Masset
