Nobody was surprised at the Federal Reserve’s 25-basis-point interest-rate cut Wednesday.
But one phrase the Federal Open Market Committee used is causing some divergence of opinion among some of the biggest investment shops out there. And the phrase has everything to do with rate cuts in 2020, for which stock investors are still hungry.
First, let’s review the facts.
The rate cut brings the federal-funds rate, the rate at which banks lend to each other overnight, to a range of 1.25% and 1.5%. This was priced into treasurys, with the 10-year yield little changed at 1.78% and the 3-month yielding 1.61%. Stocks seesawed, then all three major U.S. indexes rose.
The FOMC said, “The committee will continue to monitor the implications of incoming information for the economic outlook as it assesses the appropriate path.”
In the past, that type of phrase has worried investors, as it can sometimes indicate the Fed will be less compelled to cut rates. Stock investors want a low-rate environment, as it stimulates growth in what is now a decelerating U.S. economy.
On Wednesday, third-quarter GDP was reported at an annualized 1.9% growth rate, lower than the 2% seen in Q2 and far lower than this expansion’s high of 4% in Q3 2018.
In Wednesday’s GDP report, business investment, which contracted 3% year-over-year, was a drag on growth. Poor business sentiment and hesitance among executives to invest have been a theme of late, as uncertainty about the direction of tariffs constrains companies’ confidence in demand.
Still, the GDP result for Q3 beat expectations, as a 2.9% increase in consumer spend buoyed growth.
But “without explicitly stating, the Fed appears to be on hold from cutting rates further in the near term,” said Charlie Ripley, senior investment strategist for Allianz Investment Management. “It feels like the completion of a 75-basis-point insurance cut is an appropriate measure absent an exogenous shock to the market.” The three rate cuts in 2019 are “insurance cuts” meant to safeguard the economy from potential roughness.
Jason Pride, Glenmede’s chief investment officer of private wealth said investors “will likely scrutinize the speeches of voting members over the next few weeks for insight into their thought processes.”
But one strategist says the Fed’s comments indicate investors will indeed see the March 2020 rate cut they want. In response to the FOMC’s comment, UBS’s Leslie Falconio, senior investment strategist of global wealth management, told TheStreet, “the insurance cuts are not done and now [the Fed is] going to move to a data-dependent trajectory, which is a bit easier to predict.”
Falconio was referring to the decelerating economic data the market has observed in the past year-and-a-half, which furthers the case for more rate cuts, as Fed Chairman Jerome Powell wants to continue the current expansion.
With the S&P 500 up 21% year-to-date, and the average stock in the index trading at 17 times next year’s earnings, Falconio doesn’t advise adding too much risk to one’s portfolio. Others cite the continuing expansion and accommodative interest rate environment as reason to believe stocks still have some upside left.