FOMC where it needs to be for a `treacherous political year'

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With Federal Reserve Board Chair Jerome Powell and other Fed officials asserting no need to change to rates any time soon, the minutes of the most recent Federal Open Market Committee meeting still may offer some tidbits

As recently as Monday, two Fed presidents — albeit hawks — stated their position that rates should remain at the current 1.50% to 1.75% range.

Federal Reserve Bank of Boston President Eric Rosengren, who dissented on the three recent rate cuts, reiterated his concern about low rates in a Bloomberg interview and ruled out negative rates, even if a recession occurs.

Federal Reserve Bank of Cleveland President Loretta Mester said in a talk the panel can take a wait-and-see approach before deciding its next move.

Indeed, the markets expect the Fed to remain “in a holding pattern for the near term,” said Gary Pzegeo, head of fixed income at CIBC Private Wealth Management.

In testimony before Congress last week, Powell stated “the current stance of policy is likely to remain appropriate as long as the data supports,” he said. "Powell also indicated that a push to raise rates would likely require ‘serious’ inflation,” which, of course, is not expected.

Pzegeo said he’ll pore through the minutes looking for: “Any advancement in the change to the monetary policy framework; indications of the definition of ‘serious’ inflation; the degree to which previously dovish dissension has been assuaged by the last rate cut.”

Fed officials have shown “an impressive consistency” on terming the economy and policy as being “in a good place,” said Greg Staples, head of fixed income, Americas at DWS Group. “While perhaps not explicit, this will be the tone that comes out of the Fed minutes: a consensus that after three cuts, the Fed has taken sufficient action to counter the potential negative effects global economic weakness and restrictive trade policy.”

For the Fed to make more, there would have to be a drastic change to its economic outlook. “The read-between-the-lines conclusion is that, particularly given the treacherous upcoming political year 2020, the Fed is right where it wants to be and would like to remain there for a considerable period of time,” Staples said.

And it may be true the three “insurance” rate cuts have helped the economy.

“Global growth should recover,” according to a Morgan Stanley research report “as trade tensions and monetary policy are easing simultaneously for the first time since the downtrend began.”

Although growth next year will be slower than this year, “the economy is on stronger footing, with less external drag, sustained easy monetary policy, and continued support from fiscal policy,” the report states. “Business investment, which slowed sharply in 2019, should make a tepid comeback in 2020.”

The Fed will be on hold until core personal consumption expenditures hit 2.5% on a year-over-year basis, at which point Morgan Stanley would “pencil in two hikes in the back half of 2021.”

The yield curve is again positive and “the paranoia over what some had described as an ‘imminent’ recession appears to have died down due to rebounding economic growth prospects,” Jason Pride, chief investment officer — private wealth, and Michael Reynolds, investment strategy officer at Glenmede write in a strategy note.

Glenmede expects the expansion to continue into 2020, although trade headwinds will “dominate the market narrative.”

But the forecast remains difficult to pin down. “At the risk of sounding like a broken record, this continues to be an extremely challenging economic environment to analyze, with mixed signals,” according to Nick Reece, a senior analyst and portfolio manager at Merk Investments.

While his base case is continued economic growth, Reece sees a 30%-45% chance of a U.S. recession in the next six months.

“The trend in much of the data is concerning and the data probably needs to start improving soon if the U.S. economy is going to weather the current soft patch," he said. "Of greatest concern are the depth and duration of yield curve inversion (10yr-3m) and the weakness in the U.S. manufacturing PMI (now below 50 for three consecutive months). The yield curve (10yr-3m) has recently uninverted, but the jury is still out as to whether this is good or bad, as steepening after inversion is historically consistent with imminent recession.”

Despite increased uncertainty around the outlook, Reece says, “the U.S. business cycle picture near-term is overall still slightly more positive than negative.”

The Fed is watching the markets, noted Zach Abraham, principal/CIO at Bulwark Capital Management. "91% of household wealth is in financial assets and 8% is in real assets. When you consider the fact that the wealthiest and largest generation in our nation's history is retiring in mass and now relying on said financial assets to replace income, the market is the economy," he said.

While market pullback late last year was attributed "to decreased consumer spending in the fourth quarter, in reality, consumer spending dipped 8% BECAUSE the market dropped 20% in 2 months."

"We’re likely to see a level of nuance that will remind investors yet again that the Fed’s path isn’t set in stone," said Bill Merz, head of fixed income research for U.S. Bank Wealth Management. "The Fed will always be data-dependent, which can cut both ways with investor sentiment. But for now we don’t expect any meaningful change in messaging from the Fed nor market expectations around policy rate changes. Global policy rate cuts likely peaked in the third quarter and revived market sentiment reduces pressure for further stimulus for now. The Fed still has enough bullets in the chamber to ease policy further if it needs to in 2020."

Housing starts
Housing starts rose to 1.314 million in October from 1.266 million in September, while building permits gained to 1.461 million from 1.391 million, the Commerce Department reported Tuesday. The permits total was the highest since May 2007.

Economists polled by IFR Markets expected 1.320 million starts and 1.383 million permits.

"Led by lower mortgage rates, the pace of single-family permits has been increasing since April, and the rate of single-family starts has grown since May," according to NAHB Chief Economist Robert Dietz. "Solid wage growth, healthy employment gains and an increase in household formations are also contributing to the steady rise in home production."

The rise in starts and permits contributes “to broader GDP growth and therefore diminishes the chances of an economic recession in 2020,” said National Association of Realtors Chief Economist Lawrence Yun.

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