Thanks to low unemployment and below-target inflation trends, Fed policy makers as expected left the target range for the federal funds rate unchanged (2.25 – 2.50%). What does this mean for investors?
Household spending and business investment data were weaker than expected in the first quarter, but the Federal Open Market Committee still expects both to rebound later this year.
The committee also believes global financial conditions have eased since the start of the year, aided by supportive monetary and fiscal policies abroad.
Fed Continues Balance Sheet Reduction Program
While the FOMC opted to leave its target rate unchanged, the Federal Reserve will move forward to cut back the pace of its balance sheet reduction program. From May through August, the Federal Reserve will reinvest just $15 billion U.S. Treasuries that mature each month, down from $30 billion per month. The Fed will continue to allow approximately $20 billion of mortgage-backed securities (MBS) holdings to roll off its balance sheet per month as those securities mature.
Overall, the committee will continue to monitor the aggregate size of the Fed’s balance sheet to determine the appropriate size to implement monetary policy effectively.
U.S. equities sold off sharply following the FOMC statement, ending the day down 0.75%. Although investors widely anticipated the Fed decision, the pullback may signal investors are growing restless with the Fed’s data-dependent approach.
The unemployment rate remains anchored to historic lows and the S&P 500 Index recorded a new all-time high, yet core inflation continues to fall short of the Fed’s target while household and business conditions remain weak. The confluence of mixed signals following a remarkable equity rally off December lows provided tactical investors a good opportunity to lock in short-term gains.
U.S. Treasury yields were close to unchanged on the day. The 2-year/10-year spread fell below 20 basis points, and the front end of the yield curve remained inverted. In our view, the shape of the yield curve signals monetary conditions are remaining too tight.
As of the close of trading on Wednesday, May 1 following the FOMC press conference, Fed Fund futures had priced in a greater than 80% chance of a rate cut in 2019. As we continue to monitor macroeconomic data influencing our view on the eventual path for short-term interest rates, we remain focused on the potential effects of the committee’s balance sheet normalization policy.
Although Fed policymakers did not change their interest rate policy, their ongoing balance sheet reduction program is modestly tightening financial conditions on balance.
Despite elevated uncertainty, we do not find compelling reasons right now to justify overriding our asset allocation methodology. We continue to believe that investors should be patient and adhere to a well-constructed, diversified investment portfolio anchored to your goals and time horizon.
Do you have questions about your portfolio? Contact an advisor at Fi3 for more information.