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Fed Removes “Gradual”, Adds “Patient”, Triggers Global Risk Rally

Karl Schamotta January 30, 2019

The Federal Reserve left interest rates unchanged today, and assured investors that it would move cautiously in raising borrowing costs over the next year, as it grapples with financial market turbulence and growing evidence of an economic slowdown.

In their official statement, Federal Open Market Committee members remained broadly optimistic, highlighting a robust labour market and strong growth in household spending as factors that could keep the economy humming – but they removed language that suggested risks to the outlook were “roughly balanced”, and cut a sentence indicating that “some further gradual increases” in rates were justified.

Policymakers said, “In light of global economic and financial developments and muted inflation pressures, the committee will be patient” in proceeding with the removal of monetary accommodation. This change had been well-telegraphed by voting members of the committee over the last few weeks, with Clarida, Evans, Rosengren, Williams, and Chairman Powell suggesting that the central bank would let economic conditions evolve before raising rates further.

In removing forward guidance from the official statement, policymakers put an immense burden on Jerome Powell’s ability to articulate clearly during the press conference – which, in itself, marks the start of a new era in Federal Reserve communications. The chair will meet with reporters after every decision going forward.

In his opening remarks, Mr. Powell said that the economy looks set for continued growth, but, “despite this positive outlook, over the past few months we have seen some cross-currents and conflicting signals about the outlook”. He said that growth had slowed in some major foreign economies, including China and Europe – and that political uncertainties related to trade, the United Kingdom’s divorce proceedings, and the aftermath of a five-week federal government shutdown would continue to raise difficult questions. In a nod to the markets, he noted that financial conditions began to tighten in the fourth quarter and “have persisted in remaining tighter”.

Powell said, “these somewhat-contradictory” signals justify a more “patient” approach from the central bank.

When asked if the Fed’s next move would be an interest rate increase or decrease, Mr. Powell seemingly executed an about-face (relative to communications last year), saying, “I’m going to say that it depends entirely on the data. We’re not making a judgment, we don’t have a strong prior. We will patiently wait and let the data clarify.”

In a separate implementation note, the Fed said that its monthly balance sheet reduction would continue, but that it was prepared to exercise flexibility “in light of economic and financial developments”. This appears to reflect an effort to convince markets that balance sheet changes should be viewed through a technical lens – and not as one of the central bank’s key policy tools.

Taken in combination, these communications helped set the stage for a sharp rally in financial markets. The dollar is down sharply, with the short end of the yield curve coming under pressure – and currencies like the euro, Canadian dollar and pound sterling are stepping higher as we go to pixels. North American equity markets are surging toward the closing bell.

Risk assets have risen over the last month on the expectation that the world’s most powerful central bank would shift onto a more dovish footing, and today’s reaction suggests that markets remain highly sensitive to perceived changes in monetary conditions.

Bottom Line: The speed and scale of the Fed’s reaction to a shift in the global economic narrative raises serious questions for the future. Are problems brewing beneath the surface of the global economy more significant than many market participants currently realize? Or is this bout of weakness more transitory than it appears – meaning that the central bank could be forced into an abrupt reversal later in the year? Either way, the conditions are in place for a bumpy year…

Karl Schamotta
Chief Market Strategist

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