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.
The Fed has been accused of reacting to President’s Trump public statements that interest rates have been raised too quickly, this recent data does also give them some ammunition to refute that allegation.
As much as the Fed publicly state that they do not use the moves in the stock market to influence policy decisions, as there appears to be a direct link between retail sales and stock market performance, the movements in the stock market cannot be wholly ignored. The question may be, should the markets in the US continue to rise, at what point could this start to influence the Fed to revert to a more hawkish tone?
Much of the recent drop in inflation expectations has been down to the fall in the oil price over the past year. Brent crude has now climbed back to mid-60 dollars, the level that is often considered ideal for the global economy. Not too high to damage spending and company costs and not too low to have a significant negative impact on those economies that produce it. Any changes in oil prices from this level could also change the Fed’s current perceived stance.
An interesting chart produced by Goldman highlighting the correlation between stocks and sectors in the recent past. How much to stocks and sectors trade in line with one another? Apparently, during periods of high correlation, it is harder to create Alpha for a fund manager. Stock correlation tends to rise as the Fed loosens monetary policy and falls when the tightening as one can see from the attached chart. Correlation has recently been increased as the Fed has changed its policy language in the previous weeks. We have tried to highlight periods of looser policy, correlation rises and visa versa