The bond market may get a boost after the Jan. 29‐30 Federal Open Market Committee meeting, according to observers who expect the panel to provide further signals of a pause in rate increases and a softening of its stance on balance sheet normalization.
“We believe investors are expecting confirmation of a rate hike pause in the January post‐meeting statement and comments,” said Ron Alberts, senior vice president, director of fixed income strategies, and portfolio manager at Johnson Financial Group. “Investor disappointment would likely lead to a flight‐to‐safety and a decline in risk assets. Confirmation of a pause would help support risk assets.”
Robert Johnson, chairman and CEO of Economic Index Associates, a macroeconomic research firm, will be looking for clues as to potential changes in the unwinding of the balance sheet. “My belief is that the Fed will reinforce that it will continue to be data dependent and no aspect of monetary policy is on autopilot.”
Balance sheet reduction will be front and center, according to Duane McAllister, managing director and senior portfolio manager, of Baird. “I think the market will be most focused on what Chairman [Jerome] Powell may say in the post‐meeting press conference about the Fed's balance sheet unwind, looking for any hints if the gradual path of asset reduction could be altered in the future if economic data were to disappoint.”
The Fed is expected take a hard look at many markets at its meeting.
“The markets seemingly have a greater effect on Fed policy today, than in years past,” according to Josh Siegel, CEO at StoneCastle. “I wouldn't say the market is driving policy, but the Fed is now far more sensitive to the reactions of the market as a general barometer of mood.”
Inflation and the yield curve will take a back seat to other forces.
“I would expect commentary about the effect of the shutdown on the economy and stress in global markets to reduce the hawkish stance,” Siegel said. “China is slowing, Europe remains slow with the [European Union] stating that significant stimulus must stay in place, and many emerging markets are approaching crisis levels. If even a hint of this is in the post meeting statement, we can expect no increases in Fed Funds in 2019.”
The markets have recovered since the prior meeting, so “the Fed won't have to spend as much time trying to convince people that the U.S. economy remains relatively strong and can maintain its current forecast of two 2019 rate hikes,” said Steven Jon Kaplan, CEO at True Contrarian Investments LLC.
If the fed funds target remains at 2.25% to 2.5%, as expected, and the post‐meeting statement avoids direct reference to the partial government shutdown, while touting economic momentum, labor market strength, vigorous consumer spending, and “softer business sentiment,” Morgan Stanley economists expect “limited” market reaction. “Without an update to the Summary of Economic Projections and a new dot‐plot, the meeting is unlikely to move rates markets—which we see as priced for the flexibility and patience,” they wrote in a report.
However, an update on balance sheet normalization principles “has the potential to move the rates market, depending on its contents,” the Morgan Stanley economists wrote. In particular, markets would move if the Fed provided clarity on how the duration of the SOMA portfolio will evolve once the balance sheet has reached its equilibrium size. Aiming for a smaller duration would lead to a yield curve steepening, while aiming to keep the duration in line with Treasury issuance would lead to outperformance of intermediate‐sector Treasuries, in our view.”
While the FOMC is apt to suggest “patience,” Stephen J. Taddie, managing partner at Stellar Capital Management, noted, “The exact wording [of the post‐meeting statement] will lead analysts to refine their forecast for Fed Funds rate levels during the year. At present, we believe there are potentially two more rate hikes in the cards for 2019, but a pause as is until summer.”
Susan Hill, senior portfolio manager and head of government money market group at Federated Investors, suggested the statement will “acknowledge that the ongoing government shutdown has not only disrupted the release of regular economic data but may have an effect on the economy if it is prolonged. We also expect the Chair to field questions about the Fed’s approach to balance sheet management.”
Charles Self, chief investment officer at iSectors, LLC, said, “With the recovery in the stock market, the statement is likely not to have many changes.”
The Fed should be on hold “absent clear inflationary pressures,” said Brian Koble, Chief Investment Officer at Hefren‐Tillotson. “The most underappreciated aspect of what's happening today is that the trade war—to the extent it has smothered the Chinese economy and tempered inflation pressures—could actually extend the economic cycle if it means the Fed is less eager to raise interest rates.”
The Fed will remain cautious as it balances “the prospect of slower growth around the world, particularly in China” and trade issues with a strong U.S. economy, according to Richard A. Muskus, president of Patriot Bank, N.A. he said he expects the Fed to hold rates “through the next series of meetings in an attempt to better balance rate decisions with prolonged stabilized economic results.”
White House interference with the Fed could also be an issue, according to Robert Frick, corporate economist at Navy Federal Credit Union. “Powell will be asked again about pressure from the White House, and he will remain resolute in maintaining the Fed's independence.”
While the post‐meeting statement won’t be altered significantly, he said, “we bet that any nuanced change will be set in a tea cup along with other recent Fed leaves and interpreted to support the analyst's position, whatever it may be.”