Fed Holds the Clues to Investors’ Big Questions in 2019
(Bloomberg Opinion) -- As the dawn of 2019 approaches, one story in markets and the economy seems set to dominate all others: When is the Federal Reserve going to stop increasing interest rates?
This may turn into a tense dance for investors and the Fed, as seen on Wednesday as markets rallied strongly in response to dovish commentary from Chairman Jerome Powell. Every upward tick in financial markets and every strong economic data point will ratchet up the pressure for investors to bet on the end of the tightening cycle. The consequences of a bet that's too early or too late are likely to be enormous.
Whenever the Fed is in the middle of a rate tightening cycle and the yield curves are flattening out, investors are going to naturally start to wonder whether rate hikes are nearing their end. The last three years in which we saw the yield curve this flat in the middle of a tightening cycle were 1999, 2005 and 2006. In all three cases, the following year represented some combination of the end of rate hikes and the economy beginning to roll over. That may be a relatively small sample size, but it represents most of the professional memory for current market participants.
Forecasting the end of rate hikes is of special importance for fixed income traders. They have lived through nearly a decade of low interest rates in the U.S. and the rest of the developed world. Considering how long interest rates spent at or near zero this decade, it would be natural to think that whenever we get another downturn, central banks, including the Federal Reserve, will cut interest rates right back to zero, where they could presumably sit for years. The traders who time this just right will reap windfall profits. At the moment, markets are pricing in an end to rate hikes around the end of 2019, but aren't currently pricing in much in the way of interest rate cuts beyond that.
An end to rate hikes could also be the release valve that commodity and emerging markets have been waiting for. Rate hikes have led to a stronger dollar, which has pressured commodity and emerging markets all year long. In response to Powell's dovish comments on Wednesday, the dollar had a sharp negative reversal. An end to hikes could mark a turning point for the dollar, leading investors to finally look elsewhere for stability and growth.
And it's not just market participants who are gaming the Fed. President Donald Trump seems to complain about the Fed's rate hikes on a weekly basis, particularly when financial markets are falling. As Democratic presidential hopefuls become candidates in 2019, he may not be alone. Every rate hike by the Fed in 2019 may be cause for presidential tweets and press statements by Democratic presidential candidates. The Fed may intend to act independently of political pressure, but officials should expect intense real-time scrutiny next year.
This all will occur at a time when the Fed is already moving away from forward guidance and becoming more flexible. Beginning in January, Powell will hold press conferences after every Federal Open Markets Committee meeting – eight per year instead of the current four. It’s a good thing, because investors will have many questions: Will a weak jobs report cause the yield curve to invert as traders rush to price in a return to zero interest rates? Will a couple months of hot inflation data shift things the other way, as traders decide the Fed's tightening cycle could go further and longer than anticipated? And how will markets and politicians receive Powell's plain talk in an environment where the policy path will be more uncertain than it has been in a decade? Markets will be listening closely for clues in 2019.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Conor Sen is a Bloomberg Opinion columnist. He is a portfolio manager for New River Investments in Atlanta and has been a contributor to the Atlantic and Business Insider.
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