by Connor Darrell
CFA, Assistant Vice President – Head of Investments
Four days of stable market gains were erased on Friday as renewed concerns over the trajectory of global economic growth weighed on interest rates and equities. Early in the week, the primary focus of investors was on the Federal Reserve, which opted to hold interest rates steady following its second policy meeting of 2019. During his post-meeting press conference, Fed Chair Jerome Powell highlighted recent moderation in U.S. consumer and business spending and cited a more meaningful slowdown in Europe. A summary of individual policymakers’ projections for the future of interest rates revealed a pronounced dovish shift in future policy expectations, and markets reacted positively. Eventually however, news on Friday morning that activity in the German manufacturing sector had fallen to a six-year low seemed to spark a broad market selloff that knocked stocks off of their five-month highs.
Watching the Yield Curve
Last week, the Federal Reserve signaled that it may leave interest rates unchanged throughout the remainder of 2019, and the news pushed bond yields to their lowest levels in over a year. Market prices now fully reflect the assumption that the Federal Reserve is finished with its tightening cycle and even suggest about a 30% chance of a rate cut in 2019. The massive shift in expectations over the past few months has led to a more pronounced inversion of the yield curve, where the yield on a 10-year treasury has now dropped below the yield on a 3-month bill. We still believe that the probability of a U.S. recession in the near term remains quite low (though it is slightly higher than it was just a few months ago). Further, we caution investors against reading too much into the shape of the yield curve or using it as a trading signal. While the yield curve has historically been a relatively reliable indicator of future economic conditions and should still be monitored closely, we believe a broader view is warranted in the current environment. Monetary policy has played such a massive role in driving interest rates over the course of this economic cycle, that it may have clouded the signaling power of traditional indicators like the yield curve. As the Fed begins to moderate its approach to monetary tightening, perhaps some clarity will be restored. But in the meantime, we believe investors would be best served by sticking to long-term asset allocation targets and utilizing the market’s strong start to 2019 as an opportunity to rebalance back to those targets.