Aegon AM: Signs of discouragement among investors despite anticipated rate cut

2 aug 2019

Irina Kurochkina, fixed income portfolio manager at Aegon Asset Management, comments on the latest US Federal Reserve Decision:

“As widely expected, the US monetary regulator cut rates for the first time since 2008 in what they called “mid-cycle adjustment”. The Federal Open Market Committee (FOMC) of the Fed announced 25 basis points cut of the federal funds' target rate to the range of 2.0-2.25% and provided expectations guidance for the future policy. As a rationale for the cut, the Fed acknowledged weaker inflation, a slowdown of the world’s economic growth and trade tensions which bring more uncertainty to the businesses. The move is widely seen as an “insurance” cut because there are few signals that the US economy is in need of monetary stimulus. Most economic indicators are healthy with a record low unemployment and the US equity market on historical highs.

Meet and miss expectations

Although the rate cut was anticipated and priced in by the markets, there are signs of discouragement among investors. One of the reasons is that chairman Powell used somewhat confusing language during the press conference and was even accused of being too hawkish for the easing policy. So, on the one hand, the Fed met market expectations and delivered the rate cut (although perceived as a very modest one). But on the other hand, Powell mentioned there is no intention to start a full-size monetary easing cycle and future decisions are very much data-dependent. It seems that Powell is walking on thin ice trying to manage market expectations on the tight scale between disappointment in case of no actions and hyped excitement for a quick rate cut cycle.

Equity market cooled off amid expectations of more pronounced easing signals and the US yield curve flattened as short-dated bonds sold off. US President Trump – the prominent critic of the recent Fed policy - was also disappointed and mentioned in his comment that “Powell let us down”. The reaction from Trump was expected, as he is keen on having the S&P 500 Index rising and USD dollar weakening (and we saw exactly the opposite move after the FOMC). The only positive surprise for the markets was in the message that the Fed will stop the run down of the balance sheet which means that they are serious about reverting the direction of their policy from tightening to easing mode.

Next move

In the coming weeks, the market expects to listen to the comments from the FOMC members to get more clarity and confirmation regarding the future actions of the regulator. There is a possibility that on the next FOMC meeting they are not going to surprise the markets with new expansionary actions as they will need to take into consideration the uncertainties around the ongoing trade war, pending Brexit and general slowing growth around the world. Thus, for the September meeting, the Fed can either mute their decision to see how markets develop or to introduce another moderate cut of 25 bps to support their “mid-cycle” easing. Looking forward, the majority of market participants expect 2-3 additional cuts by the end of 2020.

In Europe, given that the Fed is now following a very moderate easing path, we expect the ECB will be also more cautious in their September meeting and can potentially postpone any sizable actions before the world sees further easing coming from their US colleagues.”