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Fed Must Encourage 'Fairly Priced' Markets

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Thursday, 31 January 2019 09:37 AM Current | Bio | Archive

After the FOMC meeting had concluded, and during the press conference, which was the start of the regular press conferences that the Federal Reserve has now put in place, it became rapidly clear that Fed Chair Jerome Powell, after the FOMC had decided the leave interest rates unchanged, did not wish to disappoint the markets.

The FOMC statement and the press conference taken together were more ‘dovish’ than either economic data or past commentary might have led investors to expect.

The role of short-term inflation data in driving monetary policy got some particular emphasis, with inflation today relatively unexciting, which generates a relatively dovish tone. The balance of risks was more symmetrical as well.

To justify a rate hike, Powell said indications of building inflation would be key.

During the press conference the Fed Chair said: “The case for raising rates has weakened somewhat. The traditional case for rate increases is to protect the economy from risks that arise when rates are too low for too long, particularly the risk of too-high inflation. Over the past few months, that risk appears to have diminished. Inflation readings have been muted, and the recent drop in oil prices is likely to push headline inflation lower still in coming months.”

Investors should better keep in mind that all this does not rule out further rate increases from the Federal Reserve. What is clear, is that the Fed has shifted market expectations.

The Fed Chair comments on the Fed balance sheet suggest that further reductions will continue over the course of this year. This is in fact more of a technical thing. The Fed is balancing money supply and money demand through its quantitative policy actions and it is perhaps best not to interpret this either as a tightening or as an easing of policy, but simply as a stabilization of economic liquidity.

The equity markets liked what they heard. The press conference included a specific question of whether a Powell ‘put’ had been put in place for financial markets. Unsurprisingly, that question remains unanswered…

It does seem clear that the Fed wishes to avoid unnecessary financial market volatility, which is fine. The worry would be, if the Fed thought rising equity markets were a good thing to be encouraged. Rising equity markets are not good by themselves. ‘Fairly priced’ equity markets are good.

That is a very important distinction that long-term investors should keep in mind.

A rise in equities today, is consistent with fairly valued markets and therefore good, but the Fed presumably would not want this to go too far.

Euro Area First Estimate of GDP growth rate in Q4

We just got the flash estimate of Euro area GDP growth rate during the fourth quarter that came in at 0.2 percent, matching the third quarter GDP growth rate, which had been the lowest growth rate since the second quarter of 2014.

For the whole year, the first estimate of the annual GDP growth rate for the Euro area came in at 1.8 percent.

There was quite a lot that went wrong in the Euro area at the end of last year. German automakers’ problems, transport problems and protests hurt domestic demand and slower global investment spending disproportionately hurt Euro area export growth.

Many of those things should stabilize or reverse over the course of 2019, but that has apparently not stopped the moderation of activity during the fourth quarter of last year.

Brexit Saga Continuous

The interminable tedious UK-EU divorce process has the European Union now declaring they absolutely will not renegotiate.

That in turn may encourage the UK to ‘wait’ until there is a ‘new’ European Commission that will ‘take office’ on November 1st this year to negotiate with.

Delaying the UK exit date will of course change who sits on the other side of the table from the UK, which of course could be very important.

Investors should remain vigilant. The road of Brexit will remain full of surprises until the story will finally be over. How and when will remain the key unanswered questions until then.

Etienne "Hans" Parisis is a bank economist who has advised investors on financial markets and international investments.

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Rising equity markets are not good by themselves. ‘Fairly priced’ equity markets are good.
fed, fairly, priced, stock, market, rallies
Thursday, 31 January 2019 09:37 AM
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