In an abrupt and surprising change in policy, the Federal Reserve announced last month that there will be no interest rate hikes in 2019, and perhaps only one in 2020.
It was widely believed the Fed would increase the Federal Funds Rate, which affects mortgages, credit cards, home equity loans and more. At first, the expectation was to increase four times in 2019. Then it was twice. And now, rates will remain where they are (which is still historically low).
The sudden about-face is the first time in 10 quarters that there has been no rate tightening. It’s a direct result of the equity volatility in late 2018 and the Fed’s expectation of modest inflation in 2019.
These factors also caused the Fed to slow shrinking its balance sheet, which will begin in May and come to a full stop in September 2019. While unexpected, this policy aims to keep rates down over time.
So far, the markets have reacted positively. Since late January, yields have fallen, equities have rallied, and credit spreads have tightened, meaning the premium investors demand to take credit risk has tightened. Plus, interest rate volatility has fallen to near all-time lows, as the chart below indicates.
Policy Important, But Earnings Still King
While the changes instituted by the Fed have been a catalyst for a good start to 2019, the policymaking body can only control so much. Earnings still matter. Interest rates will still move based on actual economic performance data, regardless of the Fed.
If inflation picks up, a rising rate environment will take place, no matter what the Fed policy is at the moment. Conversely, if global or domestic growth slows, interest rates will likely fall, irrespective of what the Fed does.
While the policies have been positive for the market in general, we don’t want to overvalue the Fed when it comes to both interest rates and market performance. It’s vital to stay cognizant of what really matters, which is earnings, because political and economic outcomes are still uncertain, and investors shouldn’t let uncertainty lull them into a sense of complacency.
Without a doubt, this is big news. But it’s still only a single data point in a sea full of them.
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