Market & Economic Outlook

The Fed's Decision

6 Minute Read

No Surprises from the Fed

In a widely-expected decision, the Federal Reserve's (Fed) Federal Open Market Committee (FOMC) cut the Fed Funds rate by 25 bps yesterday and moved short term rates to a range of 2.0 to 2.25%.

Markets had expected a rate cut following comments from FOMC Governors and Chairman Powell as longer term Treasury rates declined, flattening and inverting the yield curve and sending a clear message that the economic outlook was worsening.

Risk assets have responded to the prospects of a rate cut by moving the S&P 500 index up more than 20% so far this year, and investors assume a rate cut will create a floor under current stock valuations. If the Fed did not cut rates at the July meeting, disappointing the assumptions of equity investors, U.S. equity markets might respond negatively.

Key Takeaways

  • Yesterday's "insurance cut" is a prudent move given changing market and economic conditions. We believe the economy is in a late expansionary phase with more runway to grow and we see no evidence of the imbalances that might trigger a recession.
  • We expect economic growth to moderate but the economy continues to grow and is highly adaptive, resilient and sufficiently dynamic to adjust to nearterm challenges.
  • A prolonged and intensified trade conflict and the currency devaluations which could follow are major near-term areas of concern.
  • We are cautious regarding risk assets until we see evidence that growth can re-accelerate, corporates profits can rebound, and event risks are cleared.
  • We are comfortable with our current portfolio positioning and see no reason for any material changes at this time.

 

The Fed is on Your Side

The FOMC's decision to trim rates can be seen as an "insurance cut," or one done during relatively strong economic conditions to sustain the economic cycle against a backdrop of softening growth, subdued inflation, and heightened global uncertainty regarding trade and tariffs. Notably, this is the first cut of any kind since the Great Financial Crisis spurred the Fed to drive rates from 5.5% to 0%.

The Fed's view on rates has shifted 180 degrees from a hawkish hiking basis — nine separate rate hikes from 2016 to 2018 — to a dovish easing stance in just the last six to nine months. And the easing trend is global, with cuts from the Central Banks of Korea, Indonesia, Ukraine, Turkey, and South Africa. The European Central Bank recently indicated they will also be more accommodative to stimulate Eurozone growth.

Concerns regarding the impact of trade conflicts on growth at home and abroad have garnered much attention, and there is a real risk of escalation and adverse consequences from trade spats. But the impact of nine rate hikes and quantitative tightening may have been underestimated by investors and likely played a significant part in slowing domestic growth.

The impact of tightening often takes between 12 and 18 months to become apparent and may be a significant factor in the current slowdown. As a result, the Fed now realizes it needs to reverse the impact of rate hikes to remove one potential cause of slowing growth.

Notably, this is the first cut of any kind since the Great Financial Crisis spurred the Fed to drive rates from 5.5% to 0%.

 

Looking Forward

We are now in the third major slowdown of the current expansion as measured by Gross Domestic Product (GDP) and growth in corporate profits, with the pain mostly felt in the trade, manufacturing, and capital investment sectors of the economy. The consumer sector, which represents 70% of the economy, and the banking system both remain in solid shape diminishing the chances of a severe downturn.

However, there is a tug of war between weakening macroeconomic fundamentals and the stimulus of monetary easing. Many investors today see the benefits of risk assets like equities outweighing the present challenges to growth. At current valuation levels, and amid growing uncertainty, stock markets appear priced for perfection, enjoying a "goldilocks" climate which could prove overly optimistic. As a result, we are cautious regarding risk assets until evidence that growth can re-accelerate, corporates profits can rebound, or event risks are cleared.

The Fed rarely cuts rates once and futures markets expect three cuts between now and year-end to move the Fed Funds rate from 2.5% to 1.75%. However, we believe it is important to remember that this FOMC is heavily data-dependent and strong data releases between now and 2020 may lead to fewer cuts than expected by optimistic markets.

 

What is the Impact on my Portfolio?

We believe in building long-term, durable client portfolios designed to weather periodic monetary policy events. As we digest the implications of yesterday's announcement, we will reassess our outlook to determine if any asset allocation changes are warranted but we are comfortable with our current positioning and see no reason for any material changes at this time.

We will, however, be watching closely at several key data points to be released in the next few weeks including employment, retail sales and inflation to determine if our asset allocation weightings need to be revised.

We welcome the opportunity to speak with you to discuss our views. Please contact your relationship manager if you would like to discuss your overall investment strategy or would like additional insight into current market conditions. Thank you for the trust you've placed in us to serve your financial needs.

 

Economic and Market Perspectives is a publication of HighMark Capital Management, Inc. (HighMark). This publication is for general information only and is not intended to provide specific advice to any individual or institution. Some information provided herein was obtained from third-party sources deemed to be reliable. HighMark and its affiliates make no representations or warranties with respect to the timeliness, accuracy, or completeness of this publication and bear no liability for any loss arising from its use. All forward-looking information and forecasts contained in this publication, unless otherwise noted, are the opinion of HighMark, and future market movements may differ significantly from our expectations.

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HighMark, an SEC-registered investment adviser, is a wholly owned subsidiary of MUFG Union Bank, N.A. (MUFG Union Bank). HighMark manages institutional separate account portfolios for a wide variety of for-profit and nonprofit organizations, public agencies, public and private retirement plans, and personal trusts of all sizes. It may also serve as sub-adviser for mutual funds, common trust funds, and collective investment funds. MUFG Union Bank, a subsidiary of MUFG Americas Holdings Corporation, provides certain services to HighMark and is compensated for these services. Past performance does not guarantee future results. Individual account management and construction will vary depending on each client's investment needs and objectives. The benchmarks referenced in this piece are used for comparative purposes only and are provided to represent the market conditions during the period(s) shown. Benchmark returns do not reflect the deduction of advisory fees, custody fees, transaction costs, or other investment expenses, but the returns assume the reinvestment of dividends and other earnings. An investor cannot invest directly in unmanaged indices. Investments employing HighMark strategies are NOT insured by the FDIC or by any other Federal Government Agency, are NOT Bank deposits, are NOT guaranteed by the Bank or any Bank affiliate, and MAY lose value, including possible loss of principal.

 

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