Jerome Powell, The Grinch of the Federal Reserve
Federal Reserve Chairman Jerome Powell seems to have been inspired by his viewing of the Dr. Seuss’ movie The Grinch this December. As Christmas was approaching, Chairman Powell, the Grinch himself, and his other Federal Reserve (The Fed) cronies were busy discussing raising rates and normalizing the balance sheet. The Fed —this group of Grinches—seemed resolute in their pledge to raise interest rates and normalize the bloated balance sheet.
Normalization was a euphemism for shrinking the giant balance sheet that had gone from $800 billion in 2008 to $4.5 trillion by 2015-17. However, by late fall and early winter, prior to Christmas Eve, the global economies, including the US, started slowing. The fourth quarter looked weak and this slowing appeared as if it would continue into the first quarter of 2019. The stock market as measured by the S&P 500 rolled over 20% during a 3-month period, bottoming on Christmas Eve. Instead of the typical “Santa Clause Rally,” we had the “Grinch Bear Market.” As coincidence would have it, Chairman Powell and the rest of the Federal Reserve had a change of heart almost exactly on Christmas Eve, just like the Grinch. This change of heart—and change in Fed policy—was confirmed by numerous presentations and interviews by Fed Reserve governors during January.
The January 30th Federal Reserve Open Market Committee (FOMC) decision was to keep rates unchanged within the bounds of two-and-a-quarter and two-and-a-half percent. This was a complete reversal from the rhetoric in late fall, prior to Christmas Eve. In addition, the speed with which the Fed plans on reducing its balance sheet has been slowed. Last year, the fed talked about balance sheet reduction being on autopilot. As assets rolled off, they would not be reinvested. Now they are more flexible with regards to the size of the balance sheet and speed of reduction. Net-net the Fed went from quantitative tightening and higher rates to quantitative pause and stable rates. Going forward, the Fed reemphasized that it is data dependent, and the markets have recognized the future is dependent on the economic data. The data dependency calls for a pause in quantitative tightening. The stock market has rallied back to within a percent of its September highs and bonds have rallied, with rates on the ten-year treasury dropping from 3.25% to 2.50%. The Fed, which contributed to the “Grinch Bear Market” in the fourth quarter has now contributed to the “Change of Heart Rally” that we’ve experienced since Christmas Eve.
While interest rates have historically approximated nominal GDP growth, the Fed’s postponement of normalization means rates could stay low for longer. This creates difficulty for investors searching for income or trying to reduce risk in a balanced portfolio.
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