Fed Chair Jerome Powell reiterated the Federal Open Market Committee’s“patient” mantra in his testimony to Congress today. He also emphasized that any future policy moves would be “data dependent”. Powell stopped short of resounding the dovish comments from New York Fed President and FOMC Vice-Chair John Williams, who said that GDP growth or inflation would have to materially surprise on the upside to warrant any further rate hikes this year. Data due this Thursday are likely to show GDP growth at 2.5% annualized in the fourth quarter, but it is expected that growth may drop below 2% for the first quarter.
The Fed’s new cautious stance towards rate hikes should help subdue longer-term U.S. Treasury yields. Short duration bonds also tend to perform well late in an economic cycle, while core fixed income protects portfolios heading into a downturn. We remain cautious, the U.S. equity market is higher quality and has defensive characteristics. However, international equities show long-term growth prospects and cheap relative prices, making them a potentially valuable long-term investment.
Non-farm payrolls increased by 304,000 jobs in January, well above expectations of under 200,000. The unemployment rate rose to 4.0%, largely due to effects of the recent government shutdown. Wage growth was steady, increasing at 3.2% year over year. Gains in both payrolls and wages should bolster consumer spending and thus overall economic growth in 2019. However, employment is a lagging indicator, so the impressive gains we’ve seen recently likely reflect the acceleration in growth from 2Q and 3Q of 2018.
Trade talks with China continue in DC next week, with President Donald Trump saying he may let the 1st March deadline “slide”. A final agreement won’t be made until Presidents’ Trump and Xi meet in person, which won’t happen until after the deadline. With both putting their reputations on the line, any deal probably has a good chance of sticking.
Earlier this week, U.K. Prime Minister Theresa May said there’s a possibility of delaying Britain’s departure from the European Union which is currently planned for March 29. This is the first time she’s been open to pushing back the deadline but with Parliament expected to oppose leaving with no deal, there are little options left on the table. The extension could potentially buy her time through the end of June, however, the European Union would still have to approve any delay and they have made it clear they would require a plan for how the delay would lead to a resolution.
For investors, all of this is a mixed bag. On the one side, economic growth seems to be slowing both in the U.S. and internationally, although it should stabilize if we can achieve more certainty over future trade relationships. On the other side, sluggish demand is holding both central banks and inflation in check and thus should ensure a generally low interest rate environment. However, with real bond yields at still very low levels and forward P/E ratios on stocks now back above their 25-year averages, expected returns from here from U.S. bonds and stocks should be modest, highlighting the importance of broader diversification to both reduce risk and enhance overall returns.
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