Paty Berry: Change-up pitch by the Fed

By Patty Berry

The Fed’s fateful march meeting is finally over, and oh, boy, did it shake things up! The large majority of investors went into the meeting expecting the word “patient” to be removed from the communique, and it was. But investors also expected this to decision to seal the first hike in the fed funds rate in June, and it wasn’t.

Yes, “patient” was removed from the wording of the communique, but the Fed also downgraded economic growth and inflation expectations, in good measure as a result of the dollar’s strength, and explained that, although the job market has improved, it still has further to go to expand the workforce and ignite an uptrend in salaries.

Basically, everything came down to the Fed members’ forecasts, which this quarter were brought down quite a bit from their December levels. The median view of the appropriate fed funds rate for the end of 2015 fell to 0.625% in March, from 1.125% in December, or fully 50 basis points less. The GDP growth range forecast for 2015 is down to between 2.3% and 2.7% in March, from 2.6% to 3.0% last quarter, and no one sees a growth rate of 3% or more on the horizon. The rate of unemployment also fell back from 5.2% to 5.3%, to 5.0% to 5.2% in March, which means it will now take a lower rate of unemployment to trigger an interest rate hike. As for inflation, it is now expected to end 2015 at 0.6% to 0.8%, down from 1.0% to 1.6% in December.

Since March 6^th, when the outstanding February employment report was published, most investors, as reflected by market behavior, brought forward their expectations of when the Fed might move to June from September. Among the results of this shift were a strong jump in the dollar against all currencies, a rise in Treasury yields, and an initial correction in stock prices, especially those of multinationals or big exporters affected by the dollar’s strength.

But the Fed was looking at a whole range of factors: moderate growth and good consumption, but also only modest production, weakness in housing, stagnant wages and a low participation rate in the job market, low inflation and downward pressures from falling energy prices, and a very strong dollar, that reduces exports as well as import prices.

All in all, then, the Fed threw the market a change-up – a slow, slow curve ball, right after a bunch of straight, fast pitches – that duly sent the markets into a tailspin. The market’s reaction to the shift in the Fed’s message was swift and violent: the dollar plummeted against each and every currency, Treasury yields retreated to recent lows, and the stockmarket skyrocketed as the dollar fell and even oil prices bounced back.

Two days later, the markets have given back at least part of their Wednesday moves, and we are left with an economic outlook that, for now, has lost most of its shine, and the expectation that the Fed will now move later – perhaps September or October – and slower – at most two hikes this year, and most probably only one. And the Fed, to its credit, gained total flexibility to raise rates when they see fit, without being hampered by any guide previously given to the markets.

So now, the big question is, with all this information and a sort of warning by the Fed for us not to expect great excitement in the foreseeable future, whether the markets sustain their levels and re-accelerate, or if they stage some kind of correction to incorporate a more moderate outlook.