In this month’s video, Investment Director, Ritu Vohora, looks at the Fed’s dramatic shift to a more dovish stance, with an emphasis on patience. The Fed’s pause was welcomed by investors in January and is positive for risk assets. But risks remain and we are likely to see continued volatility in the coming months.
January proved something of an antidote to the tumultuous conditions for markets in the fourth quarter of 2018 – a period in which continued Fed monetary tightening, concerns about slowing growth and earnings downgrades spooked investors.
The adoption of more dovish statements from Fed Chair Jay Powell cheered markets at the beginning of January before an official statement near the end of month struck an even more dovish tone and further boosted sentiment.
The policy U-turn since the December meeting of the Federal Open Markets Committee saw the MSCI AC World Index finish up 7.9% overall (in US dollar terms), delivering its highest January return in the 32-year history of the Index. The S&P500 also posted strong gains, logging its best January returns since 1987.
In fact, equity markets across all regions posted solid gains in January, despite more subdued economic data coming from Europe and China, and lingering Brexit negotiations in the UK. Emerging market equities delivered the strongest gains in absolute terms over the month, up 8.8% (in US dollar terms) with hopes of more constructive US-China trade discussions acting as a tailwind. The Renminbi also hit a fresh 6-month high versus a weakening US dollar.
Oil prices rose in January, recovering on the back of output cuts by OPEC and Russia and amid US sanctions on Venezuela. Brent crude enjoyed its best month since April 2016. Gold inched up to a fresh 8-month high before closing out the month.
Emerging market bonds also enjoyed a strong rally in January, their best monthly gains since 2016, in the wake of the Fed’s more cautious tone, hopes of a US-China trade deal and improving current account balances.
From a sector perspective, there were gains across the board. Energy stocks performed well in January, boosted by a rising oil price. Cyclical sectors including consumer discretionary, industrials and financials were also among the strongest performers as investors’ risk appetite increased. Healthcare and consumer staples were the laggards during the month.
One of the pivotal moves helping markets regain their poise in January, was the increasingly dovish stance taken by the US Fed. The central bank stressed that it would be “patient” regarding any future rate rises and removed language in its forward guidance referring to “further gradual rate hikes”. It also signalled greater “flexibility” when it comes to shrinking its balance sheet and argued that future policy would be guided by the data. Policymakers indicated that they would be willing to use all the tools on the table if conditions warrant.
The Fed has been gradually unwinding its balance sheet and raising interest rates, delivering four rate rises in 2018. December’s rate hike, however, rattled investors and saw markets log their worst reaction to any Fed meeting since 1994 -amid signs of softening global growth, deteriorating credit growth, a weaker housing market and concerns around margin pressures.
The flattening of the US treasury yield curve added to the uncertainty and led to speculation that the Fed had tightened too aggressively. As the impact of Trump’s tax cuts begin to fade, this raised the prospect of a potential Fed ‘misstep’ tipping the US economy into recession.
However, concerns about an imminent recession, or more pronounced US economic slowdown, look to be overdone – especially in the wake of the more dovish signals coming from the Fed in January.
Recent comments suggest the committee is paying attention and is adjusting its stance accordingly. Ultimately, monetary policy remains quite accommodative, and with below-target inflation, unemployment at a near two-decade low of 3.9% and growth stable (if slowing), the Fed can afford to take a more flexible approach and pause before making any further policy changes.
Also, while there have been some indications of a late-cycle growth slowdown, the US economy ‘as a whole’ remains broadly stable.
The Fed’s direction of travel from here is less certain but, for now, it is clear the pace of tightening has slowed. Moving through 2019, this should provide something of a buffer for investors and be positive for emerging markets.
However, it would be ambitious to expect an unbridled continuation of the tailwinds that helped to reduce volatility and buoy sentiment through 2017 and much of 2018 and ongoing macroeconomic and geopolitical influences will likely spell further bouts of market volatility.
Still, volatility can provide opportunity. Despite the relief rally witnessed in January, pockets of value following the fourth-quarter sell-off could offer investors good entry points to pick up some quality businesses trading on relatively attractive multiples. The key for investors is to be selective and maintain a diversified portfolio.
The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Past performance is not a guide to future performance.