New Federal Reserve chair Jerome Powell had all kinds of excuses not to raise interest rates at last week’s FOMC meeting:
- The yield on the 10-year Treasury note was trading close to its highest point in more than four years and dangerously close to breaking the 3% barrier.
- Stocks have fallen well off their highs, and investors are nervous about the prospects of a potential trade war between the U.S. and its biggest trading partners, particularly China and Canada.
- The threat of that trade war has influenced some economic forecasters to lower their GDP growth forecasts for the first quarter to below 2%, which would be the lowest level since President Trump took office.
- The turmoil in the Trump Administration, with cabinet secretaries and other senior officials jumping ship or being pushed overboard, doesn’t help calm the waters.
Yet Powell and the seven other voting members of the Federal Open Market Committee saw fit to raise the federal funds rate by a quarter percentage point to a range between 1.5% and 1.75%. Not only that, but the FOMC stuck to its guns and indicated a steady diet of rate increases over the next three years, pushing rates closer and closer back to what used to be normal before the global financial crisis. After three rate increases this year, three more are likely next year followed by two more in 2020, which would boost the fed funds rates to a range of 3.25% and 3.5%.
And yet the world didn’t end. In fact, the yields on Treasury securities actually fell after the meeting ended on Wednesday afternoon. The 10-year note, the bond market’s long-term benchmark, trading just below 2.90% on Tuesday, fell five basis points after the meeting to 2.85%. The yield on the two-year note, which is more sensitive to interest rate changes, dropped seven bps after the meeting.
Powell and the Fed also didn’t try to talk down the current pace of U.S. economic growth. Quite the contrary. Although the post-meeting statement described U.S. economic activity as “moderate,” versus “solid” at the January meeting, it did say that “the economic outlook has strengthened in recent months.”
Despite concerns that higher rates may crimp the recovery, Powell said at his first post-meeting press conference as Fed chair that “raising rates too slowly would raise the risk that monetary policy would need to tighten abruptly down the road, which could jeopardize the economic expansion.” The Fed also raised its GDP growth forecast this year to 2.7%, up from its 2.5% forecast in December, and to 2.4% from 2.1% for next year.
Now, the Fed is notorious for producing wide-of-the-mark economic forecasts – something you want in your central bank, right? – But being more bullish than bearish about growth was a welcome sign of things to come out of the Powell Fed. As the Wall Street Journal’s editorial page pointed out, that forecast is “pessimistic compared to many private forecasters, but it’s positively giddy for the current Fed, which overestimated the growth stimulus from government spending for years after the 2008 recession.”
Even Powell advised investors not to get too carried away with the Fed’s forecasts, noting that even the supposed experts at the central bank “don’t have the ability to see that far into the future.”
Maybe that’s what has the bond market acting so strange. Why else would bond yields fall after the Fed indicated that rates are going up, by almost 200 basis points over the next two years? Perhaps bond traders and investors simply don’t believe the Fed’s relatively rosy economic picture.
But there are other factors keeping yields from moving higher. The most obvious reason, of course, is the flagging equity market, which has the jitters from the President’s declaration of a trade war and now concerns about Facebook’s business model, which has dragged down the price of other tech stocks that have carried the nine-year-old bull market most of the way. If they suddenly start to stumble, we could be staring a full-fledged bear market in stocks right in the face. That’s pushing investors into haven assets, like Treasuries.
That’s why it’s just too early to announce the end of the long bull market in bonds, which has been going on since the mid-1980s.
Has the easy money been made in bonds? Most assuredly. But every time it looks like bond yields are headed into the stratosphere – at least, compared to where they have been since the financial crisis – something comes along to make us rethink that idea.
I’ve never been a big fan of bonds, especially over the past few years. But it seems to make a lot more sense to clip your bond coupons than to lose 10% or 20% – or even more – of your money in the stock market.
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INO.com Contributor - Fed & Interest Rates
Disclosure: This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.