October FOMC MEETING – adjustment done, now wait and see
Backdrop
The Fed cut interest rates for the third time in four months, lowering its policy rate to 1.75% from 2%. The move had been widely anticipated with market participants pricing in 90% chances of a cut prior to the meeting.
Rhetoric was largely unchanged: the statement cited remaining uncertainties as well as weak investment and exports. On the positive side, the Fed reiterated strength in the labour market and economic activity growing at a moderate pace.
More broadly, other central banks have been delivering cuts and accommodation in concert since the beginning of the year and further action is not anticipated according to money markets futures pricing at this stage.
On average, no more rates cuts are expected over the next 12 months, indicating that investors consider current policy stances to be appropriate. Therefore, the next few rounds of macro data will be of paramount importance to determine the next steps in monetary policies and their impact on future returns of financial assets.
Jerome Powell telegraphed forward guidance in the usual way, leaving the door open for further support if needed. However, the reference to “acting as appropriate” was omitted, indicating at least a pause, if not the end of this mid-cycle adjustment phase.
Market Impact
The market reaction was relatively muted overall. The high degree of anticipation by the market and the minor changes in policy stance led to tepid market action.
The yield curve was among the major movers, flattening 4bps between 2y and 10y maturities, while the VIX index dropped to a three-month low of 12.5.
Asset Allocation Consequences
Three down, none to go: this FOMC meeting is casting light on the broader situation. World growth now sits at around potential levels thanks to central banks’ efforts and the time has come to observe the impact of these accommodative and “appropriate” monetary policies.
With this in mind, our current dynamic assessment revolves around three risk factors:
- Macro: Growth conditions, as depicted by our proprietary Nowcasters, have stabilised around potential globally and are showing early signs of reacceleration in the US. Inflation is nowhere to be seen yet, while ample accommodation seems guaranteed by the majority of policy makers.
- Market Sentiment: Risk appetite remains elevated thanks to a benign macro environment and fading geopolitical risks. Positioning in risk assets (and stocks more specifically) does not look particularly stretched hedging assets are starting to be unwound. Positive developments on the Brexit and trade war fronts are clearing skies on the horizon, which will be generally supportive for growth assets in the near future.
- Valuation: Most assets are expensive after such strong returns year-to-date. Government bonds remain the most expensive of all even after the yield surge in October. We remain worried about a potential mean reversion in valuations that could weigh on diversified allocations.
The global context remains supportive: stabilised/accelerating economic momentum, lacklustre inflation, central bank accommodation, fading geopolitical risks and light positioning in stock markets lead us to favour growth-related asset classes over hedging ones. On the other hand, we are still underweight inflation risk premia and increasing carry via selected EM currency pairs and credit spreads.
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