A remarkable change of fate by the Fed, which already began to surface in November last year, has reached its pinnacle last week. The era of rate hikes that began in December 2015 in the U.S. appears to have come to a grinding halt.
The Fed raised interest rates four times in 2018. After markets tolerated the initial rate hikes, the central bank became overconfident. The Fed announced that it would raise rates another three times in 2019 and that it would continue its hikes into 2020. That is where markets drew a line in the sand. The result: a sudden collapse in stock prices.
Because the bottom sharply fell out of stock prices, the Fed scrambled to announce that it would change the course of its monetary policy. Whereas the discussions a few months ago were about whether the central bank would raise rates three or four times this year, the Fed turned tables and now the debate is about whether it will raise rates just once or not at all.
A sudden stock market decline threatened to disturb economic growth. On the one hand because of the negative impact upon market confidence and on the other hand because of potential financial instability.
The Fed’s policy reversal in the last two months of last year, took away many but not all of the doubts and uncertainty in markets. As a result, the central bank took its policy reversal to its extreme.
The bottom line of the Fed’s meeting of last week is, in my view, that the Fed has gone from a stance that is best described as ‘rate hikes unless’ to a stance of ´rate hikes if´. Whereas the bank until recently had to be convinced to halt its rate hikes, it must now be convinced to raise the most important benchmark rate of the country and the world. This appears to be semantic nitpicking but is in fact something big and important. It is as if the burden of proof is suddenly completely reserved in our judicial system, that someone is not guilty only when and if courts prove your innocence!
Better yet: lower rates are not ruled out in the U.S. this year. Fed Chair Jerome Powell said that ´´a rate adjustment could also mean lower rates´´, because the central bank´s policy is not set on autopilot, but dependent upon economic developments.
When will the Fed resume the last-year announced rate hike trajectory for 2019? Well, if inflation starts creeping up the Fed will probably not resume its rate hikes at all. Powell mentioned, after all, that higher inflation would be a ‘‘large part of the need for rate hikes’’, only to add that ´´it would not be the only consideration, but a very important one nonetheless.´´
If we would repeat out loud Powell’s statements and carefully interpret his words, then he is in fact saying that if inflation in the US begins to rise, it wouldn’t be enough of a reason for the Fed to hike rates. If the economic conditions would deteriorate, the bank would keep rates unchanged. And if financial conditions would deteriorate (read: stock prices decline and interest rates rise), then a lowering of rates would certainly be possible.
In such a scenario, one should not only expect lower rates, but the Fed could also slow the pace or even completely halt its balance sheet reduction. This is how I would interpret Powell´s “… we [the Fed] will use all the tools at our disposal, including the pace of balance sheet normalization” if circumstances would require it.
There is also a historical fact that, in my view, makes it very unlikely that this rate hike cycle will be resumed. In the past, the central bank resumed such a cycle almost never after a pause. Once before did the Fed resume its rate hikes after a pause, which was in the mid-90s. But the economy was still growing at an increasingly rapid pace and labor productivity rose. Today, in 2019, growth is declining and increases in labor productivity are poor to say the least.
“Common sense risk management requires caution, we will have to wait until the picture becomes clearer’’ said Powell. In my view, this could be best translated as that the Fed will only raise rates this year if the economic outlook improves and inflation resumes its rise and financial conditions do not deteriorate.
The central bank is now definitely waiting for further, more conclusive data before it acts. In combination with the often-used word ´patience´, in the sense that the Fed must be patient with further rate hikes, then we are in for the long haul. The fact that the phrase that further rate hikes are necessary has been deleted from the committee´s press release, is much more than just a cosmetic change. If Powell says that the necessity to raise rates has declined, I would say that he expresses himself rather euphemistically. What he in fact wants to say is that the odds are very high that the current era of rate hikes has come to an end.
No wonder gold prices have been on the rise over the past few weeks. Given the outlook of structural loose monetary policy in the United States and a negligible chance of rate hikes, the current conditions especially suit precious metals prices. Having said that: the current conditions also appear to be very favorable for stock market prices. Economic growth remains high, monetary policy remains loose and inflation is low. While there is substantial uncertainty, take the meetings between the U.S. and China regarding their trade war or European elections in May, I would not be surprised if stock prices would rise over the next few months. That might put a lid on gold prices. But a rally toward $1400 per troy ounce is even then very much possible.