The Fed - Dead Ahead

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by: Mark J. Grant
Summary

The Fed is likely on hold, if not dead in its tracks.

Top Fed officials have been virtually unified in their remarks, in recent days, to stress they are going to be patient.

This is a massive about-face from their comments in the fall and from Chairman Powell's December speech.

Boston Federal Reserve President Eric Rosengren said, on Tuesday, it could be "several meetings" before the Fed has a clear enough read on the economy to take action on interest rates. It is the latest sign that the Fed is likely on hold, if not dead in its tracks. Top Fed officials have been virtually unified in their remarks, in recent days, to stress they are going to be patient.

This is a massive about-face from their comments in the fall and from Chairman Powell's December speech. What actually caused this is anyone's guess but it may have been the President's comments. My view here is that the Fed was created by Congress's passage of the "Federal Reserve Act" in 1913 and that any Congressman, or Senator, or the President, can comment on what they are doing without threatening their independence. I see nothing wrong with anyone in our government saying, "One moment please." The people at the Fed are appointed for 14 year terms and they can make their own decisions, but I see nothing wrong with them paying attention and listening.

"It may be several meetings of the Federal Open Market Committee before Fed policymakers have a clearer read on whether the risks are becoming reality, and by how much the economy will slow compared to last year," said Rosengren in his speech. He added that "patiently watching" is the best policy for now. I, personally, agree with this viewpoint.

This was the same message that I got from Jim Bullard, the President of the St. Louis Fed, when I was on CNBC's "Squawk Box" with him. He was quite clear, without the use of Fedspeak, that he was in favor of holding interest rates at the present levels, at this time. The people at the Fed seem to have not only changed their policy but the manner in which they discuss it, which is a blessing for investors.

The Fed will decide whether to raise, cut or keep interest rates the same at its meetings on March 20, May 1 and June 19. Rosengren's remarks echoed Fed Chairman Jerome H. Powell's recent testimony to Congress where the central bank leader emphasized the Fed was in "no rush" to act on rates. "There are a number of near-term risks that hopefully will be clarified by the summer time," Rosengren told The Washington Post in an interview, after his speech. "We'll certainly know whether or not there's a trade agreement with China and whether tariffs are going up or not."

For the U.S., and global economy, there is a lot riding on whether President Trump can ease trade tensions with China and Europe this spring. Numerous Fed leaders have described, in recent days, how growth overseas is slowing, which is a drag on the economy of the United States at a time when the impact of the tax cuts and fiscal stimulus appears to be fading. I would also state that they seem to be making veiled references to Brexit and the European elections which seems to concern a number of Governors and Presidents.

I would further state that if it is a "Hard Brexit" then there are a number of issue with the banks, and certain bonds, that will be a real concern. With Brexit may come a financial calamity where certain bonds, derivatives, and CoCo bonds, are no longer governed under British law and while I think they would revert to local laws who knows what games the European politicians could play with these issues.

The S&P 500 has rebounded in 2019, enjoying its best January-February start to the year since 1991, according to Bank of America Merrill Lynch. But Rosengren noted that while stocks have rebounded, credit markets have not fully bounced back, which is an indication that some investors remain quite cautious. During the last three months the Bloomberg Treasury Index is now only up 0.13% while the Corporate Index is up 0.26% and the High Yield Index is now only up 0.03% for the same corresponding time period. We certainly aren't back to "Risk On" at the present time.

The Fed is currently predicting 2.3% growth this year, down from about 3% growth last year. It is a decent level of growth but Rosengren, Powell and Vice Chair Richard Clarida have stressed "cross currents" and "head winds" are strengthening. "I would say the downside now is a higher probability than it was six months ago," Rosengren said.

A $5.7 trillion borrowing binge by U.S. companies could make a slowdown in the world's biggest economy even more painful and is one more reason the Federal Reserve was wise to put interest rate hikes on hold, Robert Kaplan, president of the Dallas Fed, said recently. Junk-grade bonds, which have ratings below triple-B and carry higher yields but also a higher risk of default, have climbed to about $1.1 trillion from $700 billion in 2008. "This substantial growth in BBB and lower-rated bonds is indicative of a weakening in corporate credit quality in the U.S.," Kaplan said.

"It's something that I'm aware of, which sort of reinforces, for me, why I feel we should be taking no action for some period of time," Kaplan said in an interview with Reuters. Companies with big debt loads may be more likely to cut spending and hiring in a downturn, "and the danger is that with a sufficient enough slowing, you'll have a greater deterioration in credit quality than you would otherwise, which could in turn amplify the slowdown," Kaplan said. He said that is "yet another reason why I think we are wise -- inflation is not running away from us -- I think we are wise to take a very patient approach."

For now, the Fed apparently sees little sign of inflation rising much above its 2.00% target. In fact, Bloomberg's Global Inflation Index is only up 0.04% during the last three months. They are also focused has turned to clarifying what they want to do with the nearly $4 trillion in assets the Fed still owns. This was derived from their efforts to revive the financial system and the economy during the 2008/2009 crisis, which began more than 10 years ago now. To this day, we still haven't escaped its effects.

Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.