The Fed delivers a dovish message

The FOMC projects zero rate hikes this year, says economic fundamentals are still strong

Mar 22, 2019 | Noelle Corum

Going into the Federal Reserve’s (Fed) March 19-20 policy meeting, markets were focused on three main themes: economic sentiment, the so-called “dot plot” and guidance on balance sheet runoff. The outcomes were considered to be dovish by markets. In addition to leaving its policy rate unchanged, the Fed revised down its US growth outlook and announced plans to end its balance sheet runoff. Initial market moves pointed to easier financial conditions, with real rates trading lower, risk assets higher and the US dollar weaker. Overall, Invesco Fixed Income expects these developments to be positive for credit risk assets.

Economic sentiment revised down
The Fed’s statement acknowledged a strong labor market but slowing growth. During Chairman Jay Powell’s press conference, he noted that underlying fundamentals remain strong and that the Fed’s outlook is positive, overall. Comments on inflation were somewhat downbeat, but largely unchanged.

Dot plot now indicates zero hikes in 2019
Federal Open Market Committee (FOMC) members now see zero interest rate hikes in 2019, as indicated by the median dot on the FOMC’s rate hike projections (or “dot plot”). This is down from two in December’s projections. The downward revision to growth projections and a rise in unemployment forecasts likely contributed to this move. Core inflation estimates were unchanged.


Balance sheet runoff to end in September
The Fed plans to slow the runoff of Treasuries from its balance sheet starting in May of this year and ending by the end of September. In October, maturing mortgage securities will be reinvested back into Treasuries up to a cap of $20 billion per month. Anything beyond this cap will continue to be invested in mortgage-backed securities. Their goal to primarily hold Treasuries in the long run remains unchanged.

Invesco Fixed Income outlook
Relative to the Fed’s median projections for growth and inflation, our expectations are slightly more constructive. We expect growth of 2.3% and core inflation to run at 2.1% in 2019, versus Fed projections of 2.1% and 2.0%, respectively. While building inflation and a solid growth outlook could bring challenges in the latter part of the year, we do not expect this to be a concern for the Fed over the next two quarters. Therefore, we believe the Fed will remain on hold for the medium term.

We believe that a dovish Fed — along with our favorable growth and benign inflation view — will likely be positive for credit risk assets. Additionally, we expect a patient Fed — combined with building inflation expectations — may steepen the yield curve and support inflation-linked bonds. Lastly, we expect the US dollar to continue to weaken. Specifically, as we see a stabilizing global growth picture and little in the way of US monetary policy, we expect the US dollar to weaken as investors look elsewhere for investment opportunities.


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