New Year, New Challenges for Federal Reserve

Economic Blog

A new wave of global uncertainty has spooked investors, and some have feared it could put too much strain on a weakened global economy without more central bank intervention.

As shown in the LPL Chart of the Day, the 2-year U.S. Treasury yield fell to 1.46% on Tuesday, below the current fed funds rate range of 1.5–1.75%. Two-year yields, which we view as a proxy for expected monetary policy, typically follow the fed funds rate unless fixed income investors expected a rate change in the near term.

Global-Headlines-Fuel-Rate-Cut-Hopes-in-Bond-Market

Now, policymakers have a chance to respond. On Wednesday, the Federal Reserve (Fed) is scheduled to deliver its first policy announcement of 2020. Investors have had a lot of news to digest after a relatively calm end to 2019, including the U.S.-China phase-one trade deal, the U.S.-Iran conflict, and the coronavirus outbreak in China.

We’ve said since October that we believe rate cuts are done for now, and this year’s headlines haven’t changed our view. Rate changes aren’t easily reversed, so the Fed must be prudent about adjsuting policy. While the headlines can be unnerving, we don’t believe recent issues merit a move (yet). The Fed could consider a rate change if conditions worsen, but for now, it’s too soon to tell.

“We don’t expect recent developments to materially impact economic fundamentals,” said LPL Financial Chief Investment Strategist John Lynch. “The Fed expects moderate economic growth in 2020, and a Fed rate pause may be warranted unless the outlook changes.”

Even though we don’t expect these new concerns to affect monetary policy, we do think Fed Chair Jerome Powell will address them. The Fed has been especially aware of downside risks recently, and policymakers have hinted they are willing to adjust rates if necessary. That messaging soothed markets in 2019, and the Fed may likely use a similar strategy to ease investors’ worries.

For more of our thoughts on the market and economic implications of the coronavirus outbreak, please read our January 28 blog post, Viral Outbreak Ends Period of Market Calm.

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The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual security. To determine which investment(s) may be appropriate for you, consult your financial professional prior to investing. The economic forecasts set forth in this material may not develop as predicted.

Please read the full Outlook 2020: Bringing Markets Into Focus publication for additional description and disclosure.

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