The medium is the message – revisited
Two years ago almost to the day, we wrote a note entitled, “The Medium is the Message”. It was in regards to the fact that the market seemed so focused on what the Fed was going to do – raise the Federal Funds rate, and by how many times – that the market neglected to focus on why the Fed was taking any action at all. That was to say that quibbling over how many times the Fed was going to raise rates, and by how much was to ignore the fact that by the Fed raising rates at all was to signal an endorsement of the health of the US economy. Similarly today, investors should pay careful attention towards the FOMC statement and actions that indicate the Fed is on pause on further rate hikes through 2019.
The Federal Open Market Committee held the Federal Funds Rate to a target of 2.25%-2.50% today. A quick glance at the “dot plots” suggests that the median expectation is for the rate to remain at its current level through 2019, with only one hike suggested for 2020. This is a more dovish posture from the last statement. Additionally, the Fed set out a plan with regards to its balance sheet normalization. “The Committee intends to slow the reduction of its holdings of Treasury securities by reducing the cap on monthly redemptions from the current level of $30 billion to $15 billion beginning in May 2019. The Committee intends to conclude the reduction of its aggregate securities holdings in the System Open Market Account (SOMA) at the end of September 2019.”
While we had been of the view that the Fed may raise rates 1-2 times in 2019, following this statement we would suggest that we have seen the end to this tightening cycle.
In its statement the Federal Open Market Committee commented “that the labor market remains strong but that growth of economic activity has slowed from its solid rate in the fourth quarter.” Further, the Fed’s economic and inflation expectations have eased since the last statement to a median expected growth rate of 2.1% for 2019 (from 2.3%) and an inflation rate (PCE) of 1.8% (from 1.9%). Recall that back in 2017 when the Fed started to raise rates at a more rapid pace the Fed Funds Rate stood at 0.75%, well below inflation at a time when inflation and economic growth was accelerating. Today, the Fed Funds Rate sits above inflation and much more in line with the historical norm at a time when disinflation and decelerating growth may be more prevalent. The Fed has made the case against further monetary policy tightening.
Canadian investors may want to consider what the Fed’s posture means with regards to currency positioning. Following the Bank of Canada’s own statement a couple of weeks ago we suggested downside risk to the Canadian dollar with our base case of no further rate hikes by the BoC and one by the Fed. If the Fed holds steady along with the BoC, the 2-year spread between the respective government bond yields will likely stay stable which may mean less downward pressure on the loonie than anticipated – although still downward pressure. We believe the downside risk to the CAD is towards US$0.73, however further downside from that level may be dependent on a rate cut by the Bank of Canada. We would suggest that a rate cut by the BoC is not an unreasonable expectation. Logic would suggest that if the Fed is on pause surely the Bank of Canada cannot raise rates given the state of the Canadian economy and in fact may need to seriously consider a rate cut.
Back in 2017 we wrote “In his 1964 book Understanding Media: The Extensions of Man, Marshall McLuhan proposed that it was the medium of communication itself rather than the message that should be the focus of study.” Today, we would highlight that the medium - no rate hikes through 2019, is the message – the economy is slowing perhaps faster than we would like to see. US equities rallied immediately following the announcement as did bonds. However, can both markets be right? By market close equities gave back the gains. Investors may want to focus on why the Fed paused in determining a course of action. To that end we feel that a more neutral asset mix with an eye towards shifting to a more defensive posture may be warranted through 2019.
Important Disclosure
A rise in interest rates typically causes bond prices to fall. The longer the average maturity of the bonds held by a fund, the more sensitive a fund is likely to be to interest-rate changes. The yield earned by a fund will vary with changes in interest rates.
Currency risk is the risk that fluctuations in exchange rates may adversely affect the value of a fund’s investments.
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