Published on Jan. 31, 2019
Release of the Doves
There were four 25 basis point increases in the Fed funds rate in 2018 and three in 2017. At the January 2019 meeting, the FOMC left the Fed funds rate unchanged at a target range of 2.25 – 2.50%. While the pause was expected, the language around it was significant. No longer are we being guided that there may be “some further gradual increases”. Instead the text of the FOMC statement is that the committee is “patient” as it decides what further adjustments might be appropriate.
This shift in sentiment comes after the markets had a tantrum in December and after a government shutdown (which may or may not resume). There are further uncertainties, particularly around our relationship with China, and the outlook definitely includes some gloominess. Perhaps there is some dust that needs to settle.
But if “patient” leaves any sense of ambiguity, Federal Reserve Board Chairman Jay Powell left little doubt at the press conference. This is not about being “patient” with regards to any further Fed funds increase. Rather “patient” is now a fork in the road, where the next change could be higher or lower. Welcome to neutral. The famous “dot plot”, Fed participant’s views of the path of rates, indicating that rates go higher is cast aside. In fairness it is not to be updated until March, at the next meeting. Look for substantial revisions. The hawks have flown off. We have the doves.
Rumblings of all this were apparent in the fourth quarter of 2018, with a noted sell off in leveraged loans as the markets sensed that economic conditions didn’t warrant higher rates. At times looking like a broad credit sell off, where everything that isn’t a government bond was for sale, in hindsight it now looks more like a liquidity event. Investors were dumping floating rate exposure, desirable holdings if rates were to move higher, but unattractive if not. They sold. What traded in the illiquid days of December was whatever could be sold. Credit spreads gapped wider. In January, gravity brought most of it back. Going forward, the economy is expected to grow, but less robustly. Growth outside the US is clearly weaker, especially in China and Europe. This creates drag to the US. Further, government policies remain a source of uncertainty. Brexit is the poster child of this, but governments globally are struggling with myriad but significant issues. This impacts confidence. Financial conditions are tighter, not only because of wider credit spreads, but simply because previous Fed engineered tightening impacts the economy with a lag. Inflation has become what looks like permanently benign. Finally, the outlook for corporate earnings is becoming more mixed. Single digit growth expectations are more common than double, as the positive effect of the tax cut legislation is anniversaried and companies face difficult comparisons. Our view remains that while growth will slow this year compared to last year’s robust numbers, the U.S. economy will still see a reasonable amount of growth.
During the fourth quarter preferred shares experienced one of their worst returns in a decade, but in January a broadly used preferred stock index has already recouped that drawdown as the market bounced back. This sort of price action shows the importance of not trying to time the market, good investment advice which spans both equities and fixed income securities. Roosevelt’s Current Income portfolio remains positioned with a mix of investment grade corporate bonds and preferred shares, the latter a mix of fixed rate and fixed-to-floating rate issues. As always, the investment team remains vigilant about the outlook and monitors the macroeconomic data on a daily basis.