BMA Market Insights: Fed Stands Pat as Global Growth Jitters Continue

While the Federal Reserve left short-end rates anchored at its policy meeting last week, the direction of long-term Treasury and mortgage rates remained unclear.

The Fed provided some insight regarding how it plans to unwind its $3.8 trillion bond portfolio, but it did not address how it plans to manage the overall duration or the maturity composition of the portfolio, which impact the direction of Treasury yields. For example, shifting its holdings from longer-term bonds to those with a shorter-term could place upward pressure on long-term yields, raise mortgage rates and steepen the yield curve. Fed Chairman Powell acknowledged that the composition of the portfolio has yet to be determined.

The Federal Reserve did, however, express a more dovish sentiment at its policy meeting, as a majority of officials did not anticipate another rate hike this year. The policy rate of 2.25-2.50% remained unchanged, with officials lowering their economic projections. The FOMC statement noted a slowdown in economic activity, with recent indications of slower growth in both household spending and business fixed investment. Powell also noted risks due to trade uncertainty and slower global growth particularly in China and Europe at the post-meeting press conference (see more below).

The Fed’s dovish stance prompted a drop in Treasury yields. Later in the week, yields were further pressured downward on the back of weaker than expected economic data coupled with an inversion in the 3-month T-Bill and 10-year treasury yield spread, reinforcing global growth concerns. The 10-year Treasury yield fell nearly 16 basis points to 2.437% and the 30-year slipped about 15bps to 2.875% over the five-day period. For the first time since 2007, the 10-year Treasury and three-month T-Bill spread turned negative, with the spread hovering around -2.2bps at Friday’s close. This inversion is largely scrutinized as an indicator for a recession, though could be explained by quarter-end repo portfolio funding adjustments. U.S. Treasury yields were not the only bonds to feel the pressure, German 10-year Bund yields turned negative for the first time since 2016 on Friday on the back of weak manufacturing data.

Concerns regarding global growth coupled with the Fed’s more cautious projections prompted all three major U.S. stock indices to end the week in the red. The S&P 500 faced its biggest one-day drop since January, closing the week at 2,800.71. Oil prices also headed south, with WTI crude hovering around $58.97 late Friday.

Across the pond, the Bank of England kept its policy rate unchanged at 0.75%, as expected, largely due to Brexit uncertainty. Regarding Brexit, the 27-members of the Euro bloc unanimously agreed to extend the divorce date to May 22nd as long as PM Theresa May can convince the U.K. Parliament to accept her proposed exit plan this week. Parliament has rejected May’s plans twice in the past few weeks (see more details below).

Outside of Brexit, a slew of economic data releases and events both domestically and abroad are scheduled throughout the week. Closer to home, market practitioners will pay close attention to various Fed officials scheduled to speak coupled with some key U.S. economic releases, including 4Q GDP, Personal Consumption Expenditures Prices, the Fed’s favored measure of inflation and housing data.

I. U.S. Economic Data/Markets

Federal Reserve kept key rate unchanged at 2.25-2.50%, and expressed a more dovish sentiment than market participants largely expected. Officials lowered economic growth forecast and marginally increased the expected rate of unemployment relative to projections in December (see table below). Key takeaways from the meeting included:
- A majority of officials (11 of 17) did not anticipate another rate hike in 2019, up from two officials who held this view in December.
- A majority of officials anticipated just one more rate hike in the next three years, whereas in December the projection was closer to three times in that time period.
- Inflation remains benign in part due to lower oil prices.
- The Fed will slow down the runoff of its balance sheet starting in May.
  - Currently, the Fed allows $30 billion in Treasuries and $20 billion in mortgage bonds to mature every month. Starting in May, the Fed will slow to $15 billion in Treasury redemptions and will stop the runoff in Treasury holdings in October.
  - The Fed ’s balance sheet currently largely comprises of Treasuries (55%) and MBS (40%). The Fed intends to get the balance sheet to consist of Treasuries and plans to reinvest MBS principal payments into Treasury securities.
  - Officials would like the balance sheet to shrink relative to the U.S. economy – as a percentage of nominal GDP, the balance sheet is about 20% of the economy – officials would like this closer to 17% by the end of September.
- Powell noted that current economic data has not directed the Fed to either lower or raise rates – re-emphasizing the Fed’s patient stance. Key points from Powell’s press conference included:
  - Trade uncertainty including Brexit was cited as risks to growth.
  - Strong labor market and rising wages reflect that the economy is in a good place, although U.S. economic data for 2019 has been mixed with slower business and consumer spending – data has been limited due to the partial government shutdown.
  - Expects a slowdown in growth in 2019 compared to 2018, noting economic activity waning in China and Europe.
- Ten-year and five-year Treasury yields hit their lowest levels in over a year, hovering around 2.539% and 2.326% respectively on the back of the announcement.

	March 2019	December 2018	September 2018
Total Expected Rate Hikes
2019	2.40%	2.90%	3.10%
2020	2.60%	3.10%	3.40%
2021	2.60%	3.10%	3.40%
Longer-Run	2.80%	2.80%	3.00%
Change in Real GDP
2019	2.10%	2.30%	2.50%
2020	1.90%	2.10%	2.10%
2021	1.80%	1.80%	1.80%
Longer-Run	1.90%	1.90%	1.80%
Unemployment Rate
2019	3.70%	3.50%	3.50%
2020	3.80%	3.60%	3.50%
2021	3.90%	3.80%	3.70%
Longer-Run	4.30%	4.40%	4.50%
Core Inflation
2019	2.00%	2.00%	2.10%
2020	2.00%	2.00%	2.10%
2021	2.00%	2.00%	2.10%

Source: Federal Reserve’s website

Manufacturing PMI disappointed the market with a reading of 52.5, a 21-month low versus expectations of 53.6.
Existing Home Sales jumped to an 11-month high with a 5.51 million seasonally adjusted run rate, reflecting an 11.8% m-o-m increase. Subdued mortgage rates coupled with increased inventory contributed to the data.
Philadelphia Fed Manufacturing Index rebounded in March coming in at 13.7 after a reading of -4.1 in February.
- Shipping jumped to 20 from -5.3 in February and new orders slightly picked up to 1.9 from -2.4.
Factory Orders edged up 0.1% in January versus expectations of a 0.3% increase.
- Declines in demand for electronic and metal products contributed to the data.
- Shipments fell for the fourth consecutive month, the longest streak since mid-2015.

II. Outside the U.S.

Brexit – Members of the E.U. granted a Brexit extension to May 22nd as long as PM May can obtain Parliament’s approval for her proposal this week (scheduled for either Tuesday or Wednesday). The modest delays allow time to enact the legislation to implement her plan if approved.
- If May is unable to get the votes needed, then a short extension to April 12th was granted by the EU bloc. If the UK needs more time beyond the April 12th date, it would then have to take part in European Parliament elections in May, per EU stipulations – this may open the door for a much longer delay regarding the UK leaving the EU.
China/U.S. Trade Talks – U.S. trade officials including Treasury Secretary Mnuchin and Robert Lighthizer are scheduled to travel to China this week for another round of trade negotiations. Chinese officials are expected to resume the in-person discussions in Washington D.C. next week, with both sides apparently targeting a deal by the end of April.
- Issues outstanding include: China’s policy reforms and agreeing to an enforcement mechanism per the trade deal.
U.K. Economic data
- The Bank of England unanimously voted to leave its policy rate unchanged, as expected, at 0.75%. Brexit uncertainty has kept the bank on hold.
  - BoE noted how Brexit is weighing on confidence and short-term economic activity, notably business investment while generating asset volatility.
  - BoE reiterated that the bank could move rates in either direction if there is a no-deal Brexit.
    - The pound weakened against the USD about 0.4% on the back of the news, trading at around $1.3142.
  - Separately, in a survey conducted by the BoE about 80% of nearly 300 companies interviewed felt somewhat prepared in a no-deal Brexit scenario, up from 50% in January.
- The unemployment rate hit a 44-year low, falling to 3.9% for the three months leading up to January.
- February retail sales surprised to the upside coming in at 4% y-o-y versus expectations of 3.3%.
  - Annual sales growth for the three months to February was its strongest in over two years.
EU composite PMI surprised to the downside with a level of 51.3 versus expectations of 52. February’s reading was at 51.9.
- Manufacturing PMI dropped to 47.6 from February’s 49.3, the lowest reading since April 2013. Any level below 50 signifies a contraction.
German Economic data
- Composite PMI fell to 51.1, the lowest reading since June 2013.
  - PMI manufacturing data contracted for a third consecutive month, with a reading of 44.7.
    - Manufacturing activity reached the weakest levels since August 2012.
    - New orders continued to decline.
    - Manufacturing sector laid-off workers – the first time since 2013.
  - PMI services nudged lower to 54.9 after a reading of 55.3 in February.
  - German 10-year Bunds yielded -0.1% on the back of the data – last time the bund yielded negative rates was in 2016.
- ZEW survey, a measure of economic sentiment rose to -3.4 from -13.4 in February. A delay in Brexit coupled with potential progress between U.S./China trade talks partly contributed to the data.
Canada Economic data
- Retail sales dropped for the third consecutive month on the bank of weaker auto sales. Sales sank 0.3% in January versus expectations of a 0.4% increase.
- CPI edged higher to 1.5% in February y-o-y. Fresh produce and higher mortgage costs offset the decline in gasoline prices.