Federal Reserve ActionSubmitted by Destination Wealth Management on August 1st, 2019
The Federal Reserve this week cut interest rates by 1/4 of a percent citing growing concern regarding the global economy. Chairman Powell took great care to suggest that the reduction in rates was not related to the US economy and stated that he believes expansion can continue. Instead, he cited growing global uncertainties including the current trade war.
Two Federal Reserve governors voted not to raise interest rates, so the decision was not unanimous. This is significant as a consensus viewpoint tends to give a clearer indication of future interest-rate policy. In fact, the equity and bond markets fell on speculation that the Federal Reserve would likely not adopt an aggressive easing path as many market observers had hoped. The standard disclaimer was provided (action may change based on future data). This also comes as no surprise as the Fed tends to dislike telegraphing their perspective on future interest rate cuts.
Markets have already priced in a 1/2 percent decrease in interest rates so any implication that rates would fall as expected was bound to be greeted with disdain. Equity and fixed income markets both react to expectations of future interest rate policy. Traders on an anticipatory basis take action based on perceived future Federal Reserve behavior.
It is not a surprise to us that the Federal Reserve highlights growing global uncertainty. Chairman Powell took great pains to state that the global economic uncertainty was not just related to China but instead highlighted his concern about current conditions in Europe. As you may know, the election of a new prime minister in the United Kingdom has created great uncertainty regarding the future of Brexit negotiations. A hard Brexit exit certainly would have a jarring impact on Europe and impact the overall global economy.
The interest-rate reduction announced today was justified in our view given global uncertainty. While some had hoped that the action would be more significant, we believe this is a measured response to current conditions.
It Is important to remember that the Federal Reserve can change their perspective on a moment’s notice (as it has over the course of the last nine months). If you recall, in the fourth quarter 2018 it was expected rates would rapidly increase. In the first quarter of 2019, Federal Reserve governor speeches then suggested that rates would not increase rapidly in 2019. And in the second quarter of 2019, the implication was rates would be falling. The Federal Reserve adjusts their perspective based on new data. One should not believe that any statement made today will necessarily continue to dictate policy in the future.
As you know, we have expected interest rates to fall in 2019 though not as much as some had hoped. At the end of 2018, we were skeptics that rates would rise as much as people feared. Gratefully, both of these perspectives turned out to be accurate.
We invest assets based on our expectations for economic conditions which includes the current state of the global economy. We have kept durations closer to intermediate rather than short term. We have believed for some time that investing in certain fixed income assets was likely a better solution than investing in cash.
On the US equity front, we continue to invest on the assumption that volatility will continue. Our portfolio strategies reflect our belief that interest rates will likely to be flat to down which is why dividend-oriented assets remain a part of our overall strategy. We also continue to invest in companies that we believe have the potential for appreciation because of discounts to long-term intrinsic value. We anticipate this continuing to be the case going forward.
Lastly, our underweight position in non-US equity assets and commodities will continue as we expect global growth to face continuing headwinds. Less global growth likely means less consumption of raw materials and lower non-US GDP expansion.
We will continue to monitor conditions closely as well as analyze federal reserve commentary, speeches, and policy. The entire research team at DWM is very much focused on adjusting portfolios as needed based on current conditions. We will continue to do so.
If you have any questions about this information, please let us now. Always happy to help.