Natixis Chief Market Strategist David Lafferty believes Fed policy has reached a transition point. “They’ve been raising rates since December 2015, but raising them from an extremely low starting point. Now we’ve reached a point where we are statistically pretty close to neutral,” says Lafferty. Broadly speaking, the Fed aims for a “neutral” federal funds rate – or monetary policy equilibrium – that neither restrains nor stimulates economic growth. “At this point,” according to Lafferty, “risk assets can no longer rely on this idea that monetary policy is absurdly accommodative, which is what it’s been for most of the last ten years.”
Straight talk vs. secret signals
The monetary policy decisions – and prognostications – of Fed policymakers, including Fed Chairman Jerome Powell, wield tremendous market influence, in part because they are viewed as reflecting expert opinion on the broader well-being of the American economy. But the Fed doesn’t operate in a vacuum, it operates in Washington DC.
Monetary policy viewed through the prism of politics creates all manner of speculation among market watchers about where the US economy has been, where it might be going, whether the Fed is trying to take the wheel, and what direction it’s trying to steer in. This can lead many to question whether its pronouncements should be taken at face value or if they are signaling good or bad news about the near future. Here, Lafferty says his view are contrarily conventional. “When I think about what the Fed is doing, I might be the only guy in America that actually believes what they say,” he suggests. “When they say they are data-dependent and on hold, I actually believe them. The fed funds futures market is now pricing over a 60% chance of a rate cut by the end of the year. I think that is a possibility – but I don’t think it’s a 60%-plus possibility.”
Rating the outlook
Lafferty believes that the probability of an interest rate cut in 2019 would increase if the trade dispute between the US and China further devolves into a full-blown trade war. He believes that investors should remain cautious about any news of rate cuts, maintaining that such an action is not always good news for markets. “I think people can misread Fed policy. If they actually begin cutting rates, I think that is a terrible message for equities. If the Fed is on hold, it’s more supportive for risk assets. If deflationary forces start to emerge and the Fed feels the economy is weak enough to cut rates, I don’t view that as good news for risk assets.” “A Fed that is sitting on the sidelines, that’s a nice environment for equities,” adds Lafferty. This implies the Fed believes “the economy is strong enough to avoid a rate cut, but not so strong that rates have to be raised.” For now, Lafferty maintains the Fed is trying to keep the supply of liquidity in the financial system at a certain level, but could lower rates later in the year if it's warranted by economic data. Until then, Fed rate policy is likely taking a summer break. “There’s nothing right now in the macro economy,” Lafferty concludes, “that requires them to be out running around talking about where rates are going.”
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