The Fed -- not so much "cautious" as "cooing like a dove"…

ref: - "Fed Keeps Interest Rates Unchanged; Signals No More Increases Likely This Year”, The Wall Street Journal

We're pointing you towards this WSJ article but frankly, any respectable financial news outlet would suffice. The Fed's monetary policy stance is the big news from yesterday, supplanting even the interminably shambolic Brexit process. The decision to leave rates where they were coming as absolutely no surprise to anyone of course, but the dovish nature of Chairman Powell's statement and of what was revealed about the Fed's current thinking was a bit unexpected for many observers. The so-called "dot plot" indicated that of the 17 members of the Fed's Open Market Committee responsible for policy, no less than eleven now believe that there will be no more hikes this year. Seven of them can't see one in 2020 either, up from just two at the last Fed meeting.

Moreover, the pace of the Fed's balance sheet reduction -- the "quantitative tightening" process by which the Fed is reducing its holdings of US Treasuries and mortgage-backed securities (MBS) -- is to be halved from its current rate of $30bn in Treasuries per month in May and halted entirely after September. It will continue to let $20bn in MBS to roll off per month as they mature, but after September will re-invest the proceeds back into Treasuries -- which both calls a net halt to balance sheet reduction and helps the Fed in its goal of rebalancing the balance sheet more towards Treasuries.

Such a significant adjustment in the Fed's position was certainly not widely expected, and it had some equally significant market effects. US Treasury yields tumbled further, with the 10yr falling from 2.61% to 2.53% yesterday and now trading at 2.51%. Global yields followed and investors are keeping a close eye on the 10yr German Bund in particular, where the yield is now less than 0.05% and is approaching the psychologically crucial zero level last seen in October 2016. The US Dollar took its cue from the lower rate scenario and fell out of its recent trading range.

If such action was an entirely predictable reaction to what the Fed had to stay, the moves in stocks were less straightforward. Much of this year's recovery from the sharp falls at the end of 2018 has been based on perceptions of a more cautious, less hawkish Fed, and after the announcement stocks were marked pretty sharply higher… but only briefly. What a lower rate environment, and a higher possibility of a yield-curve inversion, might mean for bank profitability caused the financial sector to put a brake on things, and most indices in fact ended down on the day.

It's tempting to think that stock prices may have reversed yesterday as investors took a wider and more considered view about what the Fed's move, or lack of it, says about the global and domestic headwinds that are causing growth forecasts to be marked lower. Don't bank on it, however… particularly in recent years, stock markets have been all too ready to be encouraged by a more accommodative policy scenario without thinking too much about the adverse conditions that provoked it. Still, the Fed is plainly worried about the factors that are reducing their growth projections. More specifically, they seem most concerned with the lack of inflationary pressure -- something that can only get worse if growth slows.

Lack of inflation discourages companies from investment and consumers from spending. We spoke not so long ago about "Japanification", which refers to the low growth and low/zero/minus inflation hole that Japan has been struggling with for decades. All other nations would like to avoid the same fate, and the Fed is said to be considering whether it might tolerate short-term rises in the inflation rate above its 2% target. Though politically contentious, the argument goes that such a plan would be balanced by the long periods of mostly below-target inflation of the recent past and would go a long way to breaking the stubborn grip of low inflation.

True or not, the more dovish position taken by the Fed is certainly understandable. The trouble is that many take the view that in the modern world where central banks have less ammunition at their disposal, monetary policy can only achieve so much -- look at Japan, for goodness sakes. There's a growing belief that fiscal stimulus will be required alongside its monetary cousin, and that's in the hands of politicians, not central bankers. The marriage between those two groups is not always happy, but assuming a plan could be agreed in principle, the central bankers would then have to ensure that any fiscal stimulus was suitably broad-based and of long-term benefit… infrastructure projects say.

What is NOT required is short-term, market-boosting tax cuts aimed at the top brackets. We've seen some of those very recently put in place by you-know-who… and sure enough, it looks like the sugar rush they provided is running out of steam already.

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