The Fed minutes overall seemed to reinforce the more dovish view investors had been anticipating. Barron’s reported that the Fed acknowledges the recent tighter monetary conditions had assisted in putting the skids under risks assets. Central bank officials are now prepared to “patient” in considering further rate rises and become flexible in shrinking the size of its balance sheet. The market now puts an almost negligible chance on another rate hike this year, with a modest chance of a cut. The consensus view on balance sheet reduction is that the Fed will curtail this by the year-end.
Equity markets have paused for breath ahead of the Fed minutes released later Wednesday. The minutes should be taken in context against the recent economic data which has led to analysts now forecasting the US economy will grow just 1% in the first quarter. This downgrade has been as a result of weak retail sales data, likewise industrial and manufacturing reports. Capacity utilisation has also started to fall. The excellent news inflation data has also weakened, this should allow the Fed the excuse to remain dovish. Consumer inflation expectations have decreased substantially in recent months. Moderate growth, modest inflation and a supportive Fed, Goldilocks is back in town.
Equity markets, particularly those in the US had another solid week, the third in a row. We questioned a few weeks ago if we were back to the days of bad economic news being good news for equity markets, as it would further encourage the Federal Reserve not to raise interest rates. If the past week is any indication this may be the case as disappointing retail sales and industrial production data falling for the first time in 8 months, did not deter investors. Likewise, disappointing outlooks from Deere and Coca Cola seemed to have limited impact. The market did get some encouragement regarding US-China trade talks. The S&P 500 has now risen almost 11pct this year. As the year started sentiment indicators were in fear territory, they are now moving much closer to greed. Valuations looked cheap at the start of the year, and the S&P 500 currently trades on 16x after this year’s rise, closer to historical averages.
Equity prices remain resilient as a combination of the Fed, trade and government shut down fears receding, has encouraged investors. Although evidence suggests investors were reluctant to take advantage of the weakness towards the end of 2018. It now appears some of the recovery may have been assisted by companies taking advantage of the weakness in share prices in December to accelerate share buyback programmes, according to a Barron’s article. For the first time company share buy backs totaled more than a trillion dollars in a year, 2018.
Fund manager surveys indicate that trade wars are their concern to the main threat for equity prices. In our opinion the theme of what the Fed might do next with interest rates will have more influence than any single other factor on the direction for equity indexes. Since December the market has gone from pricing in two rate hikes this year to the possibility that the next move may be a cut. After a miserable December, this change of tone led to one of the best January’s on record for equity indexes. Oxford Economics provides evidence that when the Fed cuts, equity prices historically go up. In contrast, eventually the Fed continuing to raise interest rates almost certainly leads to an economic recession.