Why investors shouldn’t fear the Fed

In 2018 many investors were fearful of just how much US interest rates would rise. They worried that the US central bank, the Federal Reserve, was simply on autopilot – that they would keep raising rates, tightening their balance sheet, and ignoring market volatility until the US economy went into recession.

But as it turns out those fears have proven unfounded.

A dovish stance

The Fed has come out and said that is not the case – they are not on autopilot; they are flexible; they’re aware of financial market uncertainty; and they’re aware of the global slowdown. The Fed has also let markets know they are conscious of, and will factor into rate decisions, still-benign inflation in the US, and weakness in US economic indicators.

Various US Fed officials, including Chairman Jerome Powell, have led communication around this more ‘dovish’ policy stance. (A ‘dovish’ Fed favours looser, more stimulatory monetary policy and lower interest rates; while a ‘hawkish’ Fed is looking to raise rates to cool the economy.)

Powell has said the Fed is going to be “patient and flexible”, will take a “wait and see” approach, and is “waiting and watching”. He has also said the Fed is listening to the message markets are sending through higher volatility.

Slowing growth

So, overall, the Fed has indicated more flexibility in regard to its monetary policy approach, both in terms of managing its balance sheet and most importantly, in terms of interest rates.

That makes sense. Recent US data has been consistent with slowing growth. The non-manufacturing conditions ISM index slowed, though is still solid at 56.7. Weaker imports meant the trade deficit also fell. And the Fed’s most recent bank lending officer survey showed less demand for corporate and consumer loans, and some tightening in lending standards.

Additionally, US December quarter earnings have revealed the level of earnings surprises, and earnings growth, while stronger than expected, is slowing down.

Market support

Our view is the Fed will be on hold for the first half of this year at least. I can’t rule out another hike later this year because the US labour market is still quite tight.

But we don’t see an aggressive tightening coming through in the US. In fact, we see the Fed remaining fairly patient, staying on hold for the first half of the year and then reassessing as we get into the second half of the year.

The relatively easy monetary conditions in the US and a central bank that is attuned to the risk regarding financial markets and also the flow on to the economy makes for a fairly positive environment for financial markets.

It’s basically telling us that these easy monetary conditions will remain for some time to come. That, in turn, provides some support for the US share market and for financial markets globally.