Backdrop

Last night’s FOMC meeting took investors by surprise, with a more dovish stance than expected. The Committee kept interest rates unchanged and revised lower all segments of monetary policy and expectations.

The dot plots, which indicate the Fed’s future course of action in terms of rate setting, have been revised two notches lower across a two-year horizon, suggesting no more hikes in 2019 vs. the two previously expected, and only one in 2020.

Economic projections have also taken a big hit with GDP forecasts lowered 0.2% from 2.3% in 2019 and 0.1% from 2% in 2020 to 2.1% and 1.9%, respectively. Inflation forecasts have been marked down by 0.1% over the next few years, unemployment is expected to increase and Fed funds rates have been revised lower by 0.5%, as showcased by the plots. In addition, balance sheet runoff is now expected to come to an end in September, earlier and more sharply than indicated in January.

In two words: More dovish. Our take: For a good reason.

Market Impact

Following the release of the statement, the largest moves were observed in bonds and FX markets.

Shortly after the announcement, the US 10-year yield had fallen by 7.5bps to 2.53%, its lowest level in a year. The USD had weakened by 1% on average against most peers, trading at 1.14 against the euro, 110.70 against the yen and 3.74 against the Brazilian real. Equity markets were thriving, with US and emerging stock indices briefly reversing earlier losses.

Asset Allocation Consequences

Fed dovishness is another clear sign that macroeconomic conditions are rapidly decelerating globally, with the US being no exception. The message coming from our proprietary Growth Nowcaster has been clear for a few weeks now: economic activity is rapidly slowing down and is now below potential across the globe. Central banks have U-turned and are now ready to ease monetary conditions to break this downward spiral and delay the end of this exceptional cycle as much as possible.

But… historically, central banks have never managed to prevent recessions and their actions usually tend to coincide with economic contractions. In terms of implications for asset allocation, the consequences are multiple and can be summarised as follows: risky assets had a fantastic run-up year to date on the back of expectations surrounding central bank support and cheap valuations entering into the New Year.

However, this has now been factored into prices with the equity growth premium surging and credit spreads hovering around 10-year lows. We remain cautious and keep current portfolio hedging at a high level. On the other hand, and contrary to last year’s correlation shock, government bonds should prove helpful to diversify and protect against a potential reversal in risk appetite. Finally, we have been advocating a short US dollar stance for a while, and last night’s meeting could act as a trigger for a medium term weakening in the greenback, especially against emerging, high yielding currencies.