US Economy and Rates Update December 12, 2019
At its December meeting, the FOMC voted to hold the federal funds rate target range unchanged at 1.50%-1.75%. The statement remained neutral by swapping “uncertainties…remain” for monitoring “global developments and muted inflation”. Chair Powell’s presser then delivered increased optimism around the outlook, while reaffirming that the Fed would need to see, “A significant move up in inflation that is also persistent for raising rates to address inflation concerns.
The Fed on hold through next year. For inflation forecasts, the bar for hiking rates will not be met prior to mid-2021.
Economist will follow the incoming data for signs that downside risks to the outlook increase or abate. The path for inflation remains highly uncertain while binary risks around trade remain live. The result is a Fed that is hamstrung until a more clear sign on the direction of economic activity emerges.
Investors continue to suggest buying UST 2y and 5y notes. Investors appear to think risks to monetary policy in 2020 skew asymmetrically to rate cuts over rate hikes terms of: (1) timing, (2) size, (3) pace, and (4) destination. The Fed is focused on year-end funding: if needed, the Fed will increase the amount of repo operations it is providing.
In TIPS, the FOMC’s guidance to be on hold for 2020 is likely to keep real yields stable in the near term. Investors see breakevens continuing to lead the moves in nominals within the range.
A high bar to hike in response to improving US data should blunt any USD strength, though the timing and magnitude of the selloff will depend on how quickly global growth improves and fiscal expansion kicks off. Potential December 15 tariffs remain a key short-term risk.