The Fed made a remarkably dovish pivot over the first half of the year and is widely expected to cut rates 25 bps to 2.00%–2.25% at the July 30–31 meeting. Markets now place 85% probability on two or more rate cuts in the second half of 2019. Yet while financial markets have gotten a boost from this policy shift, we see reason for caution, not celebration. Looking ahead, we see risks that the Fed adds to market uncertainty instead of offsetting it, a situation that could ignite significant volatility.
One risk is that significant Fed rate cuts are already priced in, meaning any indication the Fed will not cut as much as expected will be painful for equities to unwind. Additionally, there seems to be little consensus from Fed officials to explain this newfound dovish stance, which raises the risk of muddled Fed communication – a historically famous cause of market volatility. Then there is the risk of cutting rates that are already near historic lows. Each cut expends valuable ammunition should the economy face a deeper contraction.
Perhaps the biggest risk right now is to the Fed’s credibility, which is arguably the backbone of U.S. monetary policy. At what point are Fed rate cuts no longer about supporting the economy, but about supporting the stock market? If the equity markets view the Fed’s continued monetary easing as a sign of weakness instead of strength and stability, it could be a short-term gain but would be corrosive to the Fed’s hard-won credibility, which could cripple monetary policy in the long run.
In the end, whether the Fed delivers one or more rate cuts this year, risks of a policy misstep seem unusually high for such a traditionally disciplined institution.
Read the analysis for each indicator:
This information is educational in nature and does not constitute a financial promotion, investment advice or an inducement or incitement to participate in any product, offering or investment. FS Investments is not adopting, making a recommendation for or endorsing any investment strategy or particular security. All views, opinions and positions expressed herein are that of the author and do not necessarily reflect the views, opinions or positions of FS Investments. All opinions are subject to change without notice, and you should always obtain current information and perform due diligence before participating in any investment. FS Investments does not provide legal or tax advice and the information herein should not be considered legal or tax advice. Tax laws and regulations are complex and subject to change, which can materially impact any investment result. FS Investments cannot guarantee that the information herein is accurate, complete, or timely. FS Investments makes no warranties with regard to such information or results obtained by its use, and disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information.
Any projections, forecasts and estimates contained herein are based upon certain assumptions that the author considers reasonable. Projections are necessarily speculative in nature, and it can be expected that some or all of the assumptions underlying the projections will not materialize or will vary significantly from actual results. The inclusion of projections herein should not be regarded as a representation or guarantee regarding the reliability, accuracy or completeness of the information contained herein, and neither FS Investments nor the author are under any obligation to update or keep current such information.
All investing is subject to risk, including the possible loss of the money you invest.