Yesterday was the International Day of Happiness, and while the state of Brexit has offered little cheer, the Fed's more dovish stance appears to have spread happiness to bond markets. At the end of last year, their median expectation had been for two rate rises throughout 2019. Following yesterday's meeting, the Federal Open Market Committee (FOMC) have announced a reduction in rate hikes for this year, suggesting the next will likely be 2020. Curiously, the consensus of economists had been predicting a rate rise but the futures market already priced out this possibility. While long-term expectations remained steady at 2.75%, the so-called 'dot plot' of Fed members no longer has rates exceeding this over 2019/20/21. They also said that they would be slowing the pace they reduce their holdings of Treasuries in May from $30 billion a month to $15 billion a month, before halting it altogether in September. Against this backdrop, US treasuries rallied, the US dollar was slightly weaker and the S&P 500 US Equity Index recovered the 0.5% it had lost earlier in the day. There has been a knock on effect with government bonds around the world rallying.
The background to this shift is a less happy picture for the economy with US growth expected to be 2.1% this year, against 2.3% previously. The wording in their statement reflected flatter expectations for the economy as they note that household spending is slowing and that the labour market "remains strong" rather than "continued to strengthen". Slowing growth in China and Europe and the possible impact of Brexit were also concerns. Overall, the tone indicates a more cautious outlook and recognises that financial conditions remain tighter than they were for most of 2018. In light of other central banks loosening policy, it was becoming more difficult for the Fed to continue on its tightening path without adding further strain on the US economy.
While trade policy and Brexit uncertainty might be dampening global growth, the extent of the predicted economic slowdown warrants a more prolonged pause. The fact that the Fed announced that they will halt the run-down of their balance sheet in September highlights the impact this is having on broader financial conditions. Thirty year mortgage rates declined from close to 5% to around 4.25% last week, which should help support the housing market and ease overall conditions for households. These actions should enable the economy to withstand a prolonged trade war or slowing growth in China or Europe. While the Fed has paused for now, if these headwinds dissipate, they could resume tightening.
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