The Fed Just Went Full Dove And The Dow Jones Barely Budged

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The Federal Reserve on Wednesday threw in the towel on rate hikes in 2019 while setting a plan to stop shrinking the Fed balance sheet by the end of September. After the dovish Fed meeting, the Dow Jones and broader stock market initially rallied but closed mixed.

Fed Chairman Jerome Powell has downplayed the usefulness of the Fed policymaker quarterly projections, but Wall Street doesn’t have much else to grab onto. While leaving its key rate unchanged, the median Fed policymaker projection penciled in zero rate hikes this year and one in 2020.

But the Dow Jones index closed down 0.55%, little changed from before the Fed meeting, and briefly turning positive. The S&P 500 fell 0.3%, while the Nasdaq composite gained less than 0.1% on the stock market today. Word from President Donald Trump that tariffs on Chinese imports could stay in place for a long time weighed on stocks earlier.

Wall Street was pleasantly surprised that the Fed will scale back balance-sheet tightening, to $35 billion a month from a cap of $50 billion, before ending it in September. As part of the process, the Fed will gradually shift mortgage security holdings to Treasuries.

“It looks like it will be a bit above $3.5 trillion,” Powell said of the balance-sheet level when tightening is paused.

Ahead of the Fed meeting, Wall Street economists were divided as to whether Fed policymaker quarterly projections would indicate a prolonged hold on rate hikes or an expectation of one hike later this year. Projections in December, before the Dow Jones and other stock indexes dived close to bear-market territory, had indicated two rate hikes were likely.

Now, even though the stock market has recouped most of its fourth-quarter slide, moderating inflation and a slowdown in economic growth have taken any pressure off the Fed to raise rates. Even the sizzling labor market seems to have cooled a bit, though February’s 20,000 payroll gain dramatically overstated the extent.

But Powell indicated that the Fed is cautiously optimistic about the outlook, even as Fed projections now show that policymakers expect GDP growth of 2.1% this year, down from a 2.3% forecast in December. The Fed’s favored measure of inflation, the core personal consumption expenditures price index, still is seen coming in at 2%. The jobless rate is now seen ending 2019 at 3.7% vs. December’s 3.5% projection.

Fed Confirms End To QT

Minutes of the late January Fed meeting, which were released Feb. 20, had already confirmed that quantitative tightening, the shrinking of the Fed balance sheet as securities mature, would end later this year.

QT is the reversal of quantitative-easing asset purchases that were made to aid recovery from the financial crisis by encouraging risk-taking. By shrinking the pool of safe assets and holding down interest rates, the Fed nudged trillions in private wealth to find alternative investments and seek higher returns.

Quantitative tightening, which began in late 2017, is reversing some of those purchases, gradually reaching a pace of up to $50 billion a month.

Dow Jones Has Priced In Fed Dovishness

The Fed’s abrupt shift from hawkish to dovish in January helped the stock market recover with gusto. Yet Fed policy is no longer a catalyst for stocks. Financial markets are even more dovish than the Fed, seeing about 33% odds of a rate cut within a year. To really move markets, then, the Fed would have to signal it’s open to restarting QE or cutting interest rates.

Powell said that Fed policymakers don’t see adjustments to the balance sheet as a regular tool of monetary policy. Wall Street might be happier if it was.