Santa was in a bad mood this year. Maybe that was the Fed’s fault…
The stock market hated the outcome of Wednesday’s (December 19) Federal Open Market Committee (FOMC) meeting.
Following the meeting, the Treasury bond yield curve flattened out in disbelief. The Dow Jones Industrial fell about 900 points from its pre-meeting highs – almost 350 points lower on the day.
Remember just a few weeks ago when the long-term Treasury was trying to push above 3.4%?
After Fed Chair Jerome Powell and his crew of monetary policy voters decided on another quarter-point hike of the federal funds rate, the long-term Treasury yield fell below 3% before bouncing back slightly above 3%.
Bond traders seem to be worrying about a global slowdown.
Meanwhile, the Fed has yet to see any evidence of a slowdown and has plans to follow through with up to two more hikes next year. The Committee did drop plans for a third hike in 2019… though that wasn’t enough to soothe markets last Wednesday… or the rest of last week for that matter.
How they end the year is anyone’s guess.
Treasury yields held steady last week, but the 10-year yield ended the week below 2.8% and the yield curve is close to becoming completely flat. In other words, the difference in short-term and long-term yields is negligible and flashing a recession warning sign.
The Bureau of Economic Analysis released November personal income and outlays figures last Friday.
Personal income disappointed by moving up 0.2% on the month, falling from a 0.5% rise in October. The estimate was for a 0.3% rise in income.
Consumers racked up debt as spending rose 0.4% in November on expectations of a 0.3% rise. October spending was revised up from 0.6% to 0.8%.
The Federal Reserve’s preferred inflation gauge, the personal consumption expenditure index – or the PCE price index – rose just 0.1%, matching the same subdued rise last month. The expectation was for a 0.2% rise on the month.
When you exclude food and energy prices, core prices still only rose 0.1%. On the year, core prices were up 1.9%, as expected.
Consumer spending is outpacing income, which doesn’t bode well for future spending.
Inflation remained muted and will likely fall with dropping energy prices.
The Fed, however, isn’t seeing it that way…
The Fed Outlook
The vote to hike rates for the fourth time this year was unanimously in favor. I fully expected the Fed to hike and I’m not sure why the market seemed shocked.
According to Fed projections, inflation is expected to end 2019 at 1.9%, that’s both with and without food and energy. The PCE is the measure they’re looking at and that dropped 0.1% from the September forecast.
Unemployment is expected to remain low, with the rate staying around 3.5%.
Our economy – as measured by GDP – is expected to grow at 2.3%. That dropped from 2.5% in the September forecast.
So, according to the Fed, the economy should still be doing well enough. Inflation should still be close enough to the established 2% target, unemployment should continue to be historically low, and a couple more rate hikes in 2019 still look to be appropriate.
The Fed Chair’s comments after the conclusion of last Wednesday’s meeting were pretty much in line with the written statement.
He sees economic growth moderating.
But his outlook for 2019 is “pretty positive” overall.
Inflation has continued to surprise him, but he remains optimistic of that magic 2% target level.
Furthermore, Powell said that the current unwinding of the Fed balance sheet has been smooth; a procedure on autopilot. He doesn’t foresee any changes to current $50 billion per month reduction in balance sheet holdings.
According to many analysts and talking heads on the financial networks, Powell’s comments about the balance sheet were the catalyst for last week’s sell-off.
But at this point, it doesn’t really matter.
I believe Treasury bond traders see more future risk for deflation rather than inflation, and recession rather than continued economic growth.
We’ll see how 2019 shapes up and what the Fed ultimately does to respond. Regardless, with Dent Research, you’ll be ready.