When FED admits its error...
The most significant event that shook the world financial market this week has to be US Federal Reserve Chairman, Jerome Powell's monetary policy announcement on Thursday night. He delivered more than the market asked for at the press conference following the two day FOMC meeting:
No more rate hike in 2019. Maybe one hike in 2020 (benchmark rate is currently 2.25%-2.5%)
Translation: This tightening cycle has ended. Recall majority of FED members upheld at least two rate hikes in 2019 just three months ago.
Schedule to stop QT (Quantitative tightening) in September by re-investing the maturing MBS into US Treasury (UST). The nuance is that FED will taper the run off of UST in May from $30b to $15b and completely stop in September, AND it will let the MBS holdings mature and reinvest the proceeds back into UST with roughly the same maturity profile of its holdings.
Translation: I am happy with a FED Balance Sheet of $4 trillion and 20-25% of US GDP. Recall JP's testimony to Congress was more like 16% of GDP with $3.5 trillion holdings. Note that before QE, Fed's balance sheet was less than $1 trillion.
The market asked for a pause, they got much more.
J Powell in his speech re-iterated the strong economy and low unemployment. The market rose on the news but returned to negative sentiment afterwards. As the market digest this 180 degree change in FED's attitude, the increasing consensus is that although JP is saying everything is going well, his action proves the opposite. Now, not only have FED stopped raising rates, they also stopped shrinking balance sheet, meaning their estimate on the economy is indeed negative and potentially more concerning than they envisaged in Jan 2019.
This is effectively admitting that their stance in 2018 was too hawkish and could be a policy error. When they admit it like this, investors need to listen.
The new "Bond King" Gundlach from PIMCO also concurs this view, pointing out that this situation is eerily similar to 2007. At that time, FED also turned 180 degrees from a "tightening bias" to "emergency ease" within a couple of weeks. S&P 500 celebrated this in the following weeks with a double top. He predicts that the US stock market will close lower than the Dec low, starting in 2nd or 3rd quarter this year.
It is also worth noting that with the second measure, FED has effectively delivered an entree-sized -QE. With re-investing maturing MBS into UST, the FED is stimulating the economy without expanding balance sheet. UST has a larger effect on market yields across the board, (hence USD and yield fell dramatically across the board after the announcement) this measure has much more profound implication.
Sure enough, 3-month and 10-year US Treasury inverted on Friday night, the first time since 2007. There have been 6 such occurrence over the last 50 years, following each of which a recession occurred. Whether this tell-sign is accurate this time is yet to be seen.
(source: zerohedge.com)
Overall, this switch of attitude is USD bearish in the long term. But for now, USD is still the only game in town.
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This article does not create an advisor-client relationship. The comments, opinions and information included in this article and expressed by its author is general information only, and has not taken into account of anyone’s personal situation. You should always consult with your adviser.
