Fed pause validates market fears about U.S. growth

[February 02, 2019]  By Trevor Hunnicutt

NEW YORK (Reuters) - While the U.S. Federal Reserve's indication it is done raising interest rates - for now - has fueled stock gains, investors worry the U.S. central bank's pledge is a double-edged sword and implicit confirmation of the markets' lingering anxiety about growth.

Fed Chairman Jerome Powell said on Wednesday that U.S. economic growth is "solid" and expected to continue. But in a sharp reversal of their stance just six weeks ago, Powell said the Fed has "the luxury of patience" in deciding whether to raise rates again.

The Fed's soothing message sent the S&P 500 up 1.6 percent on Wednesday and extended into Thursday, helping the benchmark index post its biggest January percentage gain since 1987.

But investors acknowledge that the Fed's strongest signal yet that policymakers may have reached the end of its latest series of interest rate increases could reflect slower economic growth.
 

"Both the stock and bond markets applauded the Fed for its more dovish tone," said Michael Arone, chief investment strategist at State Street Global Advisors. "If you take a step back and evaluate why they're doing it, it's because they're concerned. So why shouldn't investors be concerned?"

The U.S. bond market never fully bought into the enthusiastic tenor to risk markets, including equities, year-to-date given signs of cracks in the consumer and peaking corporate profit growth.

U.S. 10-year government bond prices are trading around the elevated levels they commanded during last month's stock sell-off, with yields at 2.63 percent today compared with 2.69 percent on Dec. 31.

U.S.-based bond funds pulled in $16.7 billion in January, according to early estimates from the research service Lipper. Investors took $944 million out of domestic stock funds over the same period.

"The bond market always gets it before the stock market," said Chuck Self, chief investment officer at iSectors LLC. Stocks' sure-footedness this year may end up like 2018's hot January rally only to peter out and end in the negative.

Three- and 5-year yields are poised to dip below the 2.4 percent effective Fed funds rate for the first time since 2006, before the global financial crisis, noted Crescat Capital LLC analyst Otavio Costa on Twitter.

Powell said there were "conflicting signals" about the economy - many of them negative - including sharply slower growth in China and Europe, Britain's chaotic exit from the European Union, U.S.-China trade negotiations, effects of the U.S. partial government shutdown and rougher markets.

Traders work on the floor of the New York Stock Exchange (NYSE) in New York, U.S., January 30, 2019. REUTERS/Brendan McDermid

The Fed acknowledged that some market gauges of inflation have fallen in recent months, a trend more typical of growth slowdowns rather than an economy on fire.

The International Monetary Fund predicted the global economy will grow at 3.5 percent in 2019, down 0.2 percentage point from last October's forecasts, citing weakness in Europe and some emerging markets. It puts U.S. growth at 2.5 percent this year and 1.8 percent in 2020, in both cases likely slower than 2018's figures, which have not been finalized due to the government shutdown.

(Graphic: Fed's Powell vs S&P 500 - https://tmsnrt.rs/2TqIcyK)

"We're not favoring the U.S. market, but we're happy to own Treasuries," said Schroders Plc portfolio manager Angus Sippe. He said he does not see a recession on the horizon and gives the Fed an "A-plus" on its management of the economy. But he would rather take risk in emerging markets and wait for more evidence of U.S. corporate earnings growth.

Financial research service Refinitiv expects 14.9 percent earnings growth for the final quarter of 2018, but just 5.1 percent for all of 2019, leaving less margin for error if consumer and business fear translates into lower spending and investment.

Still, oil producers are working to stabilize prices, China is aggressively stimulating its economy and, as Bank of America Corp analysts said in a research note on Thursday, the Fed has shown that its commitment to supporting markets is alive and well. Those factors mean market pessimists are getting it wrong, according to Michael Jones, chairman at RiverFront Investment Group LLC.

Some investors appear to be positioning for the worst.

Futures contracts tied to Fed rates imply the Fed's next move will be a cut. Markets are pricing in a higher probability of two cuts by next January than of a single rate hike.

(Reporting by Trevor Hunnicutt; editing by Jennifer Ablan and Lisa Shumaker)

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