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Friday, March 22, 2019

Be Careful What You Ask For

Has anyone recovered from Wednesday’s Federal Open Market Committee (FOMC) announcement? I, for one, am still shocked and a bit annoyed at the Fed for being so open with its thoughts. The financial markets were hoping to gain clarity about future interest moves and the balance sheet reduction program. They were not expecting to have the floor knocked out from under them, or rather to have Treasury yields fall 10 to 15 basis points in a couple of days. After two days of meetings, the FOMC decided not only to leave its benchmark interest rate at the current range of 2.25 to 2.50 percent, but thought it might be best to leave the rate alone for the remainder of 2019. Federal Reserve Chairman Jerome Powell explained that while the economy is in a “good place” with a strong labor market, healthy wage gains and positive consumer confidence, the committee considers the current fed funds rate to be well-suited to the present economic outlook. The Fed expects the economy to remain stable but grow at a slower pace than in 2018.  Powell noted the continued uncertainty of the trade tariffs, slower economic growth in Europe and China, Brexit and even stubbornly low inflation as the key issues that could adversely affect our economy. When asked repeatedly during the press conference what would signal the Fed to move interest rates in either direction, Powell was semi-straight forward saying there was no data currently to suggest moving rates higher or lower, but the Fed “would act appropriately when the time comes.”
The markets’ second major question dealt with the balance sheet reduction program. The committee’s statement from the meeting noted the Fed would begin to reduce the run-off of the balance sheet in May and end altogether in September. Beginning in October, the Fed will roll its maturing mortgage-backed securities into Treasuries with a cap of $20 billion per month. The plan laid out in Wednesday’s statement was the result of discussions held during the past four FOMC meetings. The committee has not yet decided the type or duration of the new investments, but some analysts expect the Fed to choose shorter-dated investments to lower the overall duration of the portfolio. This will provide room for extension when the Fed needs to reverse course and start re-adding to the balance sheet.
The Summary of Economic Projections (SEP), a quarterly release of the committee’s projections for the economy, supported the Fed’s decisions to keep interest rates steady. The Fed lowered the forecast for 2019 GDP to 2.1 percent from 2.3 percent, inflation shifted to 1.8 percent from 2.0 percent and the unemployment rate rose to 3.7 percent from 3.5 percent. The target for fed funds at the end of 2019 decreased to 2.40 percent from 2.9 percent. 

Strategically for Credit Unions:

It is important to keep in mind that the Fed’s announcement this week was not a proclamation. The announcement for no interest rate changes this year was the opinion of a majority of Fed officials, not an official policy change. In fact, some officials believe a rate increase might be warranted in 2020. These projections are at odds with the fed funds futures market, which is predicting a 40 percent chance for a rate CUT by December. The Fed can and has changed its mind when the data and financial markets signal it is time, making it difficult to know what will happen in the next six to 12 months. If you are on the investing side flush with liquidity, the most prudent strategy might be a mixture of bonds or CDs that provide yield protection (bullets, long lockouts) along with a few bonds offering higher yields and less protection. Current coupon new issue MBS pools are also a safe strategy for mortgage buyers. 

Sarina Freedland – Senior Investment Officer

Although this information has been obtained from sources we believe to be reliable, we do not guarantee its accuracy and it may be incomplete or condensed. This is for informational purposed only and is not intended as an offer or solicitation with respect to the purchase or sale of any security. All herein listed securities are subject to availability and change in price. Past performance is not indicative of future results. Changes in any assumption may have a material effect on projected results.

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