Janus Henderson: Is patience always the best course of action?

The US Federal Reserve (Fed) continued its dovish shift on Wednesday with “patience” the current buzz word and a disguised loosening of policy. Dressed up as an uninteresting, technical adjustment, the proposal that the Federal Reserve’s balance sheet will not shrink as much as previously expected is actually an easing in monetary policy. This should be positive for financial assets, at least for a few months.

The Fed did not wish to reverse the direction of interest rates so soon after raising in December. However, members of the Federal Open Market Committee were clearly concerned enough about either the economy or financial markets to feel that something needed to be done. The significance of the shift, in just six weeks, should not be underestimated — from “further gradual increases” to “patience” and an indication that the eventual scale of quantitative tightening will be smaller than expected. Fed Chair Powell seemed to struggle to convey the reasons for the changes, a far cry from the smooth, calm image he has previously presented. In truth, there are concerns that the Fed is becoming hyper-reactive to all incoming data, both economic and financial.

The US economy is still growing strongly, even if the pace is forecast to moderate, with the impact of the government shutdown expected to be recovered. There may be ‘crosswinds’ from the rest of the world but the Fed traditionally focuses on the US domestic situation. The concern is rising that when a steady hand on the tiller is required late in the economic cycle, an overly sensitive central bank could cause financial bubbles and over-leverage that exacerbate the next downturn — as Powell alluded to in questions. Comments will also increase in volume about the influence of President Trump’s criticisms and how much the Fed is now watching financial markets rather than the real economy.

However, the move should be a boost for financial assets. Equity and credit markets had become concerned about the pace of interest rate increases against the backdrop of easing global growth. A more supportive Fed should lead to a period of more positive sentiment and probably a weaker US dollar. This could be particularly positive for emerging market asset returns, with China also making significant efforts to spur economic growth. Trade tensions remain a risk but the direction of travel seems to be that of compromise. We do not necessarily expect better sentiment to last all year but we remain positive towards emerging markets for the time being, at least until inflation forces the next Fed flip flop.