Highlights
• Fed’s seemingly steadfast commitment to raising rates and unwinding of its balance sheet fuels market concerns
• China may find path toward policy changes to end tariff war
• Troubles brewing in corporate debt markets
As we enter 2019, it may be difficult to remember the exuberance that greeted 2018. After all, the synchronized global economic recovery, which had been a predominant theme for most of 2017, helped spur consumer and business confidence, while the new $1.5 trillion Tax Cuts and Jobs Act signed into law December 22, 2017, helped ensure a strong and optimistic foundation for 2018. By early April, however, signs of slowing global growth began to emerge, even though the U.S. economic expansion was gaining momentum and corporate earnings on the top and bottom lines were delivering stellar returns.
Fast forward, and markets now are discounting an economic slowdown in the United States as well. But there is an abiding question: Are we transitioning to a slower but still solid economy, as the Federal Reserve suggests, or a deeper downturn that could result in a recession? The global synchronized recovery itself has been rebranded as the global synchronized downturn. The debate as to what brought an unraveling to a market that has only rewarded the most defensive sectors and Treasuries focuses primarily on the Federal Reserve’s path toward interest rate normalization and unwinding of its balance sheet. That’s coupled with—or exacerbated by—uncertainty surrounding the tariff war with China. Add to the list the allegedly waning “sugar high” of the tax cuts, Brexit uncertainty and market volatility triggered by high-frequency trading gone hyperbolic.
The Federal Reserve Sees 'Cross Currents'
In what has become a heated attack on Fed policy, and specifically on Federal Reserve Chairman Jerome Powell by President Donald Trump, market participants have become increasingly vocal that the Fed is inching closer to committing a policy error, one that could lead to a significant downturn. Following the Federal Open Market Committee (FOMC) meeting in late December, The Wall Street Journal’s editorial page led with “Powell to Markets: Take That.” The editorial admonishes the Fed for its decision to raise rates for the fourth time this year despite “some cross currents” that are emerging, slowing global growth, and U.S. growth projected by the Fed to shift to a 2 percent to 2.5 percent range in 2019 from 3 percent in 2018.
The WSJ editorial was blunt: The Fed told financial markets “they don’t matter all that much to the real American economy. The markets barked right back that the Fed doesn’t appreciate the current signs of financial stress that could become economic trouble in 2019.”
During the FOMC press conference Mr. Powell, while underscoring that the Fed will become increasingly data dependent, supported Fed projections for two rate hikes in 2019 by stressing that the economy should be strong enough to absorb higher rates. “We have seen developments that may signal some softening, relative to what we were expecting a few months ago,” he said, alluding to the softening global economy and periods of increased market volatility. However, “in our view, these developments have not fundamentally altered the outlook.”