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The Federal Reserve: What Me Worry?

By David Cleary, CFA | December 2018

So, it’s safe to say, the market was very disappointed by the Fed’s 25 basis points tightening yesterday as well as the guidance provided for future hikes in 2019.  Reading the FOMC minutes from November and listening to Fed Chairmen Powell’s remarks at his speech at the Economic Club of New York a few weeks ago, where he said, “We will be paying close attention to what incoming economic and financial data are telling us” many market participants were led to believe that the Fed’s next actions would be more dovish.  That did not prove to be the case.

In our opinion, incoming economic and financial data, have reached worrisome levels which should have justified a more accommodative monetary policy stance.  Falling stock prices, a flattening yield curve, widening credit spreads and lower earnings projections are all indications that maybe the Fed should have paused its policy tightening, particularly into 2019.  Given the Fed’s dual mandate of price stability and economic growth, the risks have moved to the economic growth front, not the inflationary front.

Yet, it is what it is, and investors must now contend with this monetary policy regime and the risks and opportunities which it presents.  For all of 2018, Crow Point Partners has taken a generally optimistic viewpoint on the US economy and its investment prospects.  This viewpoint and its investment implications have been quite challenging this quarter, yet we have not fully given up on risk assets and will continue to take a balanced view for our investors, looking for opportunities but also managing risks.

There is still a lot of good news on the economic front.  The US economy is still relatively strong, nominal interest rates are still low and despite the Fed’s tightening stance, overall financial conditions remain very accommodative.  That is very important for the real economy and ultimately for investors.

Chart 1

The Chicago Fed’s National Financial Conditions Index (NFCI) provides a comprehensive weekly update on U.S. financial conditions in money markets, debt and equity markets and the traditional and “shadow” banking systems. Positive values of the NFCI indicate financial conditions that are tighter than average, while negative values indicate financial conditions that are looser than average.

Yet, markets are priced at the margin and at the margin economic risks are rising, thus the selloff in equities and other risk assets over the past few months.    

Chart 2

The CBOE Volatility Index, known by its ticker symbol VIX, is a popular measure of the stock market's expectation of volatility implied by S&P 500 index options, calculated and published by the Chicago Board Options Exchange (CBOE). It is colloquially referred to as the fear index or the fear gauge.

In as much as other fundamental economic risks remain, notably trade negotiations with China, we do not believe that an overly restrictive Federal Reserve is a meaningful, going forward risk.  Given the market’s reaction, the Fed is likely to recognize the error of yesterday’s policy move and is unlikely to repeat it.  Unlike with his predecessors, an explicit “Powell put” may not exist yet we believe you can take Chairman’s Powell’s comments to heart when he says they will evaluate the incoming data. And the incoming data indicates that the Fed should be less restrictive in 2019.

Topics: Insights

Written by David Cleary, CFA

David Cleary, CFA is the Founder and Lead Portfolio Manager at Timber Point Capital Management. Previously he spent 23 years at Lazard Asset Management where he held a series of senior portfolio management roles over multi-asset and global fixed income strategies. Additionally, he served as the firm’s global head of fixed income, a $26 billion platform. Prior to Lazard, David worked at UBS and IBJ Schroder, mostly in fixed income asset management roles. He began working in the asset management field in 1987 upon his graduation from Cornell University, with a BS in Business Management and Applied Economics. He is a CFA charterholder.

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