A gift from the Fed? How the rate pause could help make conditions just right

On the latest edition of Market Week in Review, Senior Quantitative Investment Strategy Analyst Dr. Kara Ng and Research Analyst Brian Yadao discussed recently-released minutes from the U.S. Federal Reserve (the Fed)’s Jan. 29-30 policy meeting. They also dug into trade war negotiations between the U.S. and China and the latest Purchasing Managers’ Index® (PMI) estimates for Europe, Japan and the U.S.

An accommodative Fed and mediocre economic growth: The right mix for markets?

The Fed’s meeting minutes, released Feb. 20, confirmed that the central bank’s newly-adopted dovish stance has not been overblown, Ng said. “Late last year, the Fed was still on track to continue raising interest rates at a quarterly pace,” she said, explaining that the central’s bank’s dovish turn came during last month’s policy meeting, when it removed language about future rate increases, noted that inflation was muted and implied that downside risks were increasing.

So, could a more accommodative Fed help push back the onset of the next U.S. recession? Quite possibly, Ng said. “At Russell Investments, we think that late 2020 is when the risks for an economic downturn will become increasingly elevated,” she stated, explaining that this is an adjustment to earlier outlooks, which had focused on late 2019/early 2020 as the more likely timeframe.

“Had the Fed continued its quarterly rate-hiking cycle, monetary policy likely would have become restrictive by early 2019, and the U.S. Treasury yield curve probably would have inverted,” Ng said, explaining that recessions typically follow yield-curve inversions by roughly nine to 18 months.

The Fed’s pause in rate increases, Ng said, effectively helps delay the next U.S. recession. This may lead to a Goldilocks scenario of accommodative Fed policy and positive, but mediocre, economic growth—just-right conditions that could allow risk assets to gently rise.

Encouraging signs emerge from U.S.-China trade talks

Turning to trade, Ng said that the U.S. and China have made demonstrable progress in their latest round of negotiations as a key March 1 deadline to avoid an increase in U.S. tariffs approaches. “Both countries are drafting multiple memorandums of understanding, which will help serve as outlines for a deal,” she noted. This development is particularly encouraging, Ng said, because the agreements cover contentious topics like forced technology transfer, intellectual property rights, services, currency, agriculture and non-tariff barriers.

Additionally, China has also offered to buy more U.S. goods in order to narrow the trade deficit between the two nations. “China has proposed purchasing an additional $30 billion in U.S. agriculture goods, on top of pre-trade war levels,” Ng stated. For context, in 2017, China bought $24 billion in U.S. agriculture products—making this a very generous offer, she remarked.

The proposal, combined with a recent statement from U.S. President Donald Trump that the March 1 deadline could be delayed, reduces the chances of the U.S. raising tariffs on $200 billion worth of Chinese goods at the end of next week, Ng said.

Will growth stabilize in 2019?

Flash estimates of February PMI numbers in the U.S., Japan and the eurozone indicate mixed results, Ng said. “In a nutshell, the flash reading for the services component of the PMI was good, but the reading for the manufacturing component was poor,” she explained. In Japan and the eurozone, the manufacturing PMI contracted, Ng noted, while in the U.S., it indicated growth, but at below-consensus levels. The manufacturing PMI tends to be a better sign of the general health of the global economy, she said.

So, what does this say about the overall state of the economy? “Trade uncertainty and the slowdown in global growth appear to still be headwinds,” Ng said, “but going forward, I expect growth to stabilize at or slightly above trend levels in the U.S., Europe and Japan.”

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