The Federal Reserve interest rate increase drives assets lower

Markets and  Investing

 

December 19, 2018

Investors continue to digest ongoing news flow within the capital market landscape, with the latest news centering on today’s U.S. Federal Reserve’s (Fed’s) interest rate decision. Traditionally riskier asset classes fell again today, with the S&P 500 now down exactly 14 percent since its peak on September 21, 2018 and down over 6 percent for the year. While the S&P 500 closed at new lows for the year, trading activity was high, but not abnormal, and our industry contacts suggest activity was orderly.

Market prognosticators anticipated a wide range of potential outcomes from the Federal Open Market Committee (FOMC) meeting, including the Fed pausing from its stated interest rate increase campaign given recent economic weakness and volatility across financial assets — ranging from stocks to commodities to high yield bonds. However, Fed Chairman Jerome Powell did not provide as “dovish” or conciliatory of a tone as markets had hoped, even when given opportunities to further frame the FOMC’s intentions in a lengthy press conference following the decision to raise its key interest rate by 0.25 percent and also suggest two more interest rate increases for 2019. While the press conference acknowledged some weakening in global economic growth trends, and the Fed’s own projections anticipated some dampened economic activity relative to their projections from the September meeting, the Fed’s formal statement did not acknowledge a downshift in global activity. In addition, even though investors noted the Fed shifting from three anticipated 2019 rate increases to two, more bullish investors hoped that the Fed would pause altogether in the new year.

Why are investors focused on the Fed? The biggest reason is how important borrowing costs are within the United States and global economies. We have had a long regime of low interest rates, both for debt coming due in the near term, as well as longer-term borrowings. When the Fed raises its interest rate targets, this serves as a tax on consumers and businesses, increasing financing costs. The Fed is worried about inflation risks fueled by the low interest rate regime, but markets are increasingly concerned that the Fed is not as worried about a slowdown in prospective growth as they perhaps should be.

We continue to have a balanced perspective on the risk/reward for diversified portfolios. We are not anticipating a recession on the immediate horizon, but amidst concerns about trade, geopolitical angst, ongoing oil price weakness and lower growth trends, higher borrowing costs do pose a risk, particularly if the Fed is out of sync with investors’ views on what higher borrowing costs mean for the future economy.

We recognize that price volatility and persistent news flow can be difficult to digest. Diversified investors have likely benefitted from bonds acting as a partial offset to global risk assets, and while we anticipate some additional volatility as markets process today’s Fed decision alongside ongoing economic trends, we urge clients not to make emotion-driven decisions. We are here to help sync your unique needs with the global capital market opportunity set, and if we can help with anything specific, please do not hesitate to let us know. As always, we will keep you informed of our ongoing views and outlook.

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