Market Minute - January 14, 2020
by Scott Rosenquist, CFA
The minutes from the Federal Reserve’s meeting in December were released last week and there are implications for the year ahead. In 2019 we saw the Fed cut rates three times in response to economic weakness and trade uncertainty, which gave both the bond and equity markets a boost. Investors should not expect multiple interest rate cuts in 2020 as the comments from the Fed seem to have set the bar high to move interest rates in either direction.
The central bank stated that the current policy is likely to remain appropriate if the economic data remains consistent. Interest rate cuts take time to work through the economy and the Fed will continue to monitor incoming data.
The labor market continues to show strength, and inflation remains below the Fed’s target of two percent; two data points the Fed watches closely when determining monetary policy. Fed Chairman Jerome Powell has said he wants to see a sustained upturn in inflation before raising rates. The central bank is currently reviewing their framework for setting monetary policy, and their inflation target could be adjusted allowing inflation to overshoot given the persistent low level since the Great Recession. I expect to hear more about this topic later in the year.
Another tool the Fed uses to implement policy is its balance sheet. In the wake of the housing crisis, the Fed grew its balance sheet by purchasing bonds and putting liquidity into the financial markets (referred to as quantitative easing). In the fall of 2019, the Federal Reserve stepped in to help ease liquidity in the repurchase market (repo) which is considered the plumbing of the banking system where banks lend overnight. The Fed also started purchasing 60 billion dollars of Treasury bills a month in October to help with liquidity crunch which they look to wind down early this year. The financial markets have been sensitive to changes in the Fed’s balance sheet which will be closely monitored by investors as the year progresses.
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