Markets Rally as “Neutral Rate” Is Closer Than We Thought

Fed Chair Powell’s speech today sent stock markets up 2% and immediately halted this morning’s market “correction”.  The big change was Powell’s remark that rates are “just below” the neutral rate. Remember, the neutral rate is the rate the Fed is aiming to reach. The neutral rate is neither stimulative nor restrictive to the overall economy. Markets have been on edge as they feared that the Fed was on an unshakable path of continued rate hikes well into 2019. This sentiment was based on recent Fed statements and the “dot plots” produced at each FOMC meeting. It was assumed that there were four rate hikes on the horizon, one in December 2018 and 3 more in 2019. Today’s comments by Powell immediately changed that consensus to one in December and one in 2019. No doubt, the December 2018 dot plot will be closely watched. So it seems the Neutral Rate is 2.75%. It was once thought to be 3.25-3.50%. A lower neutral rate means a weaker global economy. Perhaps the “new normal” post recession world economy will require some accommodative policy after all. Today’s developments are an example of the “contrarian” economic news cycle: bad news becomes good news, (a grimmer economic outlook leads to lower interest rates in the future and markets cheer).  Powell also stressed that future policy is “data dependent” and not “set in stone”.  He also indicated concerns on the horizon: trade disputes/tariffs, Brexit, Italian bonds, and the IMF has lowered growth projections. Plus, today’s housing report showed new home sales falling to a 3 year low with inventory spiking. Corporate spreads are volatile and widening (pushing some Life Co loan spreads up also). The 10 year T hit a 2 month low of 3.04% today. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners