wmc september 23

Weekly Market Commentary – September 23, 2019

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The Federal Reserve cut interest rates 0.25% last week. While the move was widely expected, various forms of dissent reflected the underlying tensions faced by the Fed. As the accompanying chart shows, interest rates dropped last week but remain above recent lows. Managing rates is difficult in an economy heavily affected by trade wars with China and negative interest rates in much of the developed world. The trade war continues to put pressure on the Chinese economy, and industrial production and retail sales growth both missed expectations last week. Oil prices rallied on fallout from the attacks on Saudi Arabian oil facilities.

Key Points for the Week

  • The Federal Reserve cut rates by 0.25% last week as expected.
  • The S&P 500 dipped slightly lower but remains near the new highs reached in late July.
  • The Federal Reserve meeting outlined many of the tensions the Fed faces when setting interest rate policy.

Global stocks slid lower after three straight weeks of increases. Last week, the S&P 500 dipped 0.5%. The MSCI ACWI index of global stocks declined 0.4%. The Bloomberg BarCap Aggregate Bond Index erased some recent losses by climbing 0.9%. Even with the decline, the S&P 500 index remains within striking distance of new highs.

Signs of progress on U.S.-China trade will likely be the key issue in coming weeks. High-level meetings are planned for October, and any progress prior to the meetings will be closely watched. U.S. durable goods orders and personal income data will provide the next update on the health of manufacturing and the consumer.

treasury yield curve

Tension at the Fed

If there is one word to describe the challenges the Federal Reserve faces, it is “tension.” The Fed is wrestling with tension stemming from within, from market participants, the government and global economic data. These tensions remain key issues for the Fed and investors as we enter a period of less certainty regarding the Fed’s next steps.

  • Internal tension: The Fed is not united in its views, and that raises uncertainty. The Fed is a consensus-driven organization, and meetings with multiple dissents aren’t common. The vote to cut rates by 0.25% was 7-3. Two governors dissented because they thought rates should be left at current levels, and one dissented because he thought rates should be cut further. A majority of the Fed governors does not favor any additional cuts.
  • Market tension: Investors do not share the majority-Fed view that no additional rate cuts are needed. Market expectations are for one to two additional cuts, while the Fed’s are between zero and one. When expectations differ, it is incumbent on the Fed to manage communication, so the market is not surprised in coming meetings.
  • Government tension: The most visible government tension is the Fed’s relationship with President Trump. The president is frequently critical of Fed policy and believes rates are too high. Investors should avoid getting caught up in this one-way commentary. Trump is more likely trying to establish a scapegoat if the economy weakens as the election approaches. Instead, focus on how tariffs and the resulting uncertainty have slowed the economy and created a challenge for the Fed. Rate cuts can help encourage broad economic activity, but they can’t target the specific challenges coming from the ongoing trade war.
  • International tension: The U.S. economy is stronger than the rest of the developed world’s and many emerging markets’, too. Growth in the U.S. is faster than in Europe and Japan. China’s recent industrial production and retail sales indicate ongoing weakness unless trade strengthens. Because the eurozone and Japan have negative interest rates, the Fed’s relatively higher rates create additional demand for U.S. Treasury bonds. Balancing its domestic role with international risks remains a tightrope the Fed must walk in coming months.
  • Data tension: The Fed stated the biggest risks to the economy come from trade and declining exports. These early-warning indicators signaled enough potential risk to spur the two most recent rate cuts. But the strong retail sales growth and low unemployment rate make it harder for the Fed to justify continuing to cut rates. Inflation has also picked up a little in recent months. Strong or weak data could shift opinion sharply given the wide divergence inside the Fed.

While all these tensions are important, the most important are how a trade deal affects the Fed and whether the early-warning indicators turn around or the retail and employment data shift. Those indicators will be the ones we watch most closely.

Fun Story

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