Fiscal policy had been the primary driver for economic and market activity for nearly two years. We are now seeing a return of central bank dominance, particularly by the U.S. Federal Reserve. This shift has significant implications for global markets.
After a decade of easy money, the 2017 Tax Cuts and Jobs Act provided incentives for investment. In 2018, the regulatory environment eased, and additional government spending programs boosted demand. The improved growth environment led to a tighter monetary stance from the Federal Reserve (Fed) in 2018. Fast forward to today, and the fiscal tailwinds of taxes, regulation, and spending are being balanced by trade headwinds, caused more by slowing economic growth in China than by trade policy. The result: a return of central bank dominance, highlighted by the U.S. Federal Reserve, which recently lowered interest rates again. As expected, on September 18 the Fed cut rates by 0.25% and made minimal changes to its statement.
Disparate views on policy were notable. There were three dissenters - two members of the Fed policy committee voted to hold rates unchanged, and one wanted a larger 0.5% cut. Only 7 of 17 members expressed the view that rates should be cut again this year, introducing more uncertainty about the next cut even though bond markets still expect another one this year. The strong characterization of the U.S. economy was also worth noting. In fact, the Fed slightly increased its U.S. economic growth forecast for 2019, despite weakening business fixed investment and exports. We expect one more rate cut in 2019 and for stocks to continue to follow the central bank’s lead. An additional rate cut may possibly benefit both stocks and bonds.
At the conclusion of the ECB’s September 12 meeting, Mario Draghi, the outgoing head of the ECB, announced a dramatic series of steps that cemented his legacy, also punctuated by his famous 2012 “whatever it takes” quote. The ECB cut its target interest rate further into negative territory by 0.1% to -0.50% and committed to purchasing 20 billion euros ($22 billion) of Eurozone debt each month until inflation achieves the central bank’s target of just under 2% growth. The ECB, and Draghi’s successor Christine Lagarde, are now committed to policy accommodation that could potentially last years. The ECB joins central banks around the world in cutting interest rates in response to slowing global growth. Export-dependent Eurozone economies, most notably Germany’s, have weakened, leading to persistently low inflation on the European continent. Prospects of a no-deal Brexit at the end of October could place further pressure on output growth.
The BOJ decided against additional policy stimulus at its meeting last week, but it did indicate it will review its assessment of its economy and inflation next month, sparking speculation that more easing measures may be forthcoming. Monetary officials have suggested they are open to the idea of further reducing interest rates into negative territory in response to weaker global growth, and they likely want to get ahead of any economic weakness resulting from a consumption tax increase slated for October. BOJ Governor Haruhiko Kuroda has previously highlighted four strategies to push rates lower: cutting short-term rates (currently at -0.1%), lowering the target yield for the 10-year government bond (currently 0%), expanding purchases of other assets such as stocks, and further expanding the monetary base. However, monetary officials also need to maintain a delicate balance by providing an upwardly sloping yield curve and supporting positive returns for life insurers and pension funds.
Despite the slowing Chinese economy, the People’s Bank of China (PBOC) chose to inject 200 billion yuan (roughly $28 billion) into its banking system rather than lowering its policy rate, disappointing some market participants. Policymakers are struggling with trying to balance stimulating growth through accommodative policies while limiting the perception of currency manipulation amid the ongoing trade conflict.
The return to central bank dominance, particularly by the Fed, has significant implications for global markets. A rate-cutting environment should support stocks. Declining interest rates help bonds, too. It may take a while before fundamentals can reassert themselves.
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- The economic forecast set forth in this presentation may not develop as predicted, and there can be no guarantee that strategies promoted will be successful.
- Data provided by LPL Financial.
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- All indices are unmanaged and cannot be invested into directly.