Markets Expect Fed to be Patient with Economy

Federal Reserve

With the next Federal Reserve Open Market Committee meeting set to begin on Tuesday, investors anxiously wait, not for a hike or not, but for more information.

Few people expect that the Fed will raise interest rates during the upcoming two-day Open Market Committee meeting scheduled to begin this Tuesday, but this one isn’t really about that. The Federal Reserve has told us that they expect a couple of rate increases in 2019, which may or may not happen, but this meeting is not expected to produce one.

What people are looking forward to during this meeting is not what the Fed will do, but what they will say, hopeful that they are seeing the economy the same way as many analysts are, meaning that there really isn’t a need to slow things down at least right now anyway.

When we look closely at the U.S. economy, as both the Fed and analysts do, we are not really seeing things move toward where an interest rate increase would seem to be needed, as it is already in a bit of a slowdown all by itself, without the need of rate hikes to slow it down further.

The idea behind these rate hikes is to keep inflation from getting too out of hand, and when we see this happening, then an increase can put the brakes on this at least somewhat, making it more expensive to borrow and leading to a contraction of the money supply.

Since our money supply is mostly credit, when we borrow less, we spend less, and when we spend less, that in itself is contractionary, because it reduces demand accordingly and this keeps prices from rising too quickly.

This happens because with a given amount of supply, the more demand there is, the more people will pay as they compete with others for the same goods and services. If demand is kept in check more, this causes a downward pressure on supply, and when this all cashes out, this also means that less profit will be made by companies, which financial markets are not fond of either.

Growth Rates are the Biggest Driver of Interest Rate Policy

The metric that we usually look at here to decide how much inflationary pressure there is out there is growth rates, and growth rates have been slowing down lately, by a bit anyway. This is in spite of many companies announcing increased earnings per share in their fourth quarter financial reports, something that the market is very appreciative about and does influence the outlook of these stocks.

About 20% of the companies listed in the S&P 500 have reported their Q4 earnings, and have averaged a 10% increase in earnings. Companies in the technology sector have done particularly well, with an average of a 13.8% increase. We still have to wait for more returns to come in to get the whole picture, but from what we’ve seen thus far, things look pretty good on that front at least.

Macro data also weighs in heavily in this equation, but overall, things look pretty good for the economy as a whole, although not to the point that we should worry too much about inflation getting too out of hand in the near term at least. Jobless claims are the lowest in 50 years, and projected growth rates are keeping up while still staying reasonable.

The IMF has downgraded their growth prediction recently from 3.7% to 3.5% for the coming year, with trade tensions factoring into this revision pretty significantly. Still though, we’re doing pretty well with all this going on, as well as other factors such as the recent U.S. government shutdown, although among the two influencers, the trade difficulties are far more influential due to both their greater scope and magnitude.

The outlook of both consumers and businesses are both holding up pretty well, and when you get a reversal of sentiment from these camps, the sentiment in itself can affect performance, if people spend less for instance, borrow less, or businesses take a more conservative approach to their production. We’re not really seeing this right now, at least to the point where we could say that attitudes are changing for the worse.

Will the Fed Maintain Their Patient Approach?

What the markets are looking for in particular from Fed Chairman Jerome Powell and his staff is more indication of the patience that they have been speaking of as of late, and patience here means that they aren’t that eager to step in when it’s not clear that actions such as a rate hike is really needed.

The Fed has already indicated to us that upcoming rate hikes will depend on what the data looks like as we move forward, which is encouraging, but we want to make sure that we’re on the same page with them as far as how the current and projected data is to be interpreted.

There does not appear to be any monsters lurking under our bed, but we want to make sure that the Fed isn’t really seeing any either.

In spite of a rate hike during the Fed’s December meeting, they did reassure us that they are going to take it slow as far as implementing more of this, and we’re looking to make sure that this is still their feeling.

We’ll find out if that is the case in just a few days, and investors will be hanging on every word, especially those that indicate where the Fed may be leaning at this time. We’ve priced in a fair bit of restraint, and this is perhaps the biggest reason why markets are higher over the last month or so, but it won’t take much to get them off that track if we hear some things during these meetings that we didn’t really expect.

This probably won’t happen though and this is one time where we have a pretty good feel where these leanings lie, but you never know for sure until the real announcements are made and intentions are made clearer.

Together with more earnings announcements from several major companies, including Amazon, Apple, Microsoft, and Facebook, the markets will have quite a bit to take in during the upcoming week.

Andrew Liu


Andrew is passionate about anything related to finance, and provides readers with his keen insights into how the numbers add up and what they mean.

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