The Fed cut interest rates today for the third time in four months, lowering the policy rate to 1.75% from 2%. The move had been widely anticipated with market participants pricing in 90% odds of a cut prior to the meeting.
Rhetoric was largely unchanged with the statement citing remaining uncertainties, and weak investment and exports. On the positive side, comments regarding strength in the labour market and economic activity growing at a moderate pace were reiterated.
Q3 2019 hedge fund letters, conferences and more
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 in money markets futures pricing at this stage. On average, no more rates reductions 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 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 yields, while the VIX index dropped to a 3-month low of 12.5.
Fading Geopolitical Risks? Asset Allocation Consequences
Three down, none to go. Today’s FOMC meeting is casting light on the broader situation. World growth now sits at around potential 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 articulates 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 due to the combination of a benign macro environment and fading geopolitical risks. Positioning in risk assets (and stocks more specifically) does not look particularly stretched and unwinds in hedging assets have started to happen. Positive developments on the Brexit and trade war fronts are clearing skies on the horizon, which will be supportive for growth assets generally in the near future.
Valuation: Most assets are rich 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 for asset allocation: 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 continue to underweight inflation risk premia and increase carry via selected EM currency pairs and credit spreads.
Article by Unigestion
