Fed primed for 2019 pause as growth, market volatility swirl

Bloomberg

Federal Reserve Chairman Jerome Powell and his colleagues are likely to turn more wary about marching interest rates higher after delivering a widely anticipated quarter percentage-point increase in December.
Prospects for slowing global economic growth, fading US fiscal stimulus and volatile financial markets all argue for more caution once officials lift rates next month near or into neutral territory, where policy neither spurs nor reins in economic activity.
Investors have already reduced bets on how many times the central bank will hike next year, partly reflecting a more dovish tone from policy makers in the past week, though a move at next month’s meeting is still firmly priced with odds above 70 percent.
“December is probably too early for pause, but we could certainly see it in the first half of next year,’’ said Gene Tannuzzo, fund manager and deputy global head of fixed income at Columbia Threadneedle Investments. “Markets need to adjust to lower and slower, both in terms of growth and interest-rate increases.”
That would probably be welcome news for a stock market that is struggling to find a floor after selling off from record highs. The S&P 500 Index has fallen about 10 percent from a September peak on a variety concerns, from worries about the US-China trade war to doubts about lofty valuations of technology shares. Corporate bond spreads have widened as well as investors have become more risk averse.
Federal Open Market Committee members in September provisionally penciled in three rate increases for 2019, according to their median forecast released at that time. They are due to update that forecast at their December 18-19 meeting.
With stocks down and growth in Germany and Japan contracting last quarter, “I wouldn’t be surprised if the Fed backs away from the three hikes it has built into 2019,’’ said Donald Ellenberger, a senior portfolio manager at Federated Investors Inc.
GautamKhanna, a senior fund manager at Insight Investment, agreed that the recent pick-up in financial markets’ volatility will probably prompt the Fed to reassess its 2019 rate hike plans. At the start of this month Khanna had expected the Fed to deliver the three hikes it signalled in September.
Collectively, traders in money-market derivative contracts are betting on just over one 2019 rate hike — pricing in only about 0.33 percentage point of tightening. That’s down from the more than 0.50 percentage point they expected earlier this month.
Some long-time Fed watchers, though, are sticking with their forecasts of four hikes in 2019, arguing that a solid domestic economy and ultra-low unemployment call for higher rates.
They include JPMorgan Chase & Co’s Michael Feroli, Goldman Sachs Group Inc’s Jan Hatzius and Bank of America Merrill Lynch’s Ethan Harris. Peter Hooper, a 26-year veteran of the Fed who is chief economist for Deutsche Bank Securities, is also currently predicting four increases, although he allowed that call could change given recent softness in inflation.
“The key question for the Fed is whether the terminal policy rate will end up lower than in previous tightening cycles. Central bank officials may not be able to precisely identify the neutral policy rate in real time, but a continual decline in the terminal fed funds rate over the past several tightening cycles serves as a cautionary reminder that a smaller dose of normalization may prove adequate this time around,” said Yelena Shulyatyeva, Tim Mahedy and Carl Riccadonna, Bloomberg Economics.
Powell will get chance to spell out the Fed’s thinking when he addresses the Economic Club of New York on November 28. Speaking in Dallas last week, he laid out a scenario for a pause in the central bank’s interest-rate hiking campaign sometime next year by highlighting potential headwinds to the US economy.