Think the Federal Reserve Is on Autopilot This Year? Think Again

A recovering global economy, a still-hot jobs market and three rate cuts already in play is supposed to mean a sidelined Fed in 2020. That was so 2019.
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A recovering global economy, a still-hot jobs market and a little extra gas from the Federal Reserve’s three interest-rate cuts last year was supposed to mean smooth sailing in 2020, with no election-year monetary policy tweaks or surprises.

But 2020 has so far been anything but normal.

Indeed, as the first month of the new decade winds down, concerns over tensions in the Middle East, the impact of the coronavirus on the global economy and markets and even the impact of President Donald Trump’s impeachment on the upcoming elections have thrown most forecasters’ and prognosticators’ expectations for Fed policy out the window.

As of Monday, fed funds futures traded on the Chicago Mercantile Exchange were pricing in an 87% chance of no change at the conclusion of the Federal Open Market Committee meeting on Wednesday afternoon, which wraps up with an official statement at 2 p.m. ET.

The fed funds target rate is currently in a range of between 1.5% and 1.75%.

While that certainly points to a majority that don't expect the Fed to move on rates at its first policy-setting meeting of 2020, expectations of “three and done” from the Fed that permeated at the end of 2019 are already being put to the test.

“Economic uncertainties appear dormant, but could awaken,” said Scott Kimball, senior portfolio manager for BMO Fixed Income, part of BMO Global Asset Management, which oversees $260 billion in assets. “Investors are pricing the Fed out of the market too quickly, assuming that geopolitics is the only risk.”

Indeed, unexpected risks already have popped up, most notably the onslaught of the coronavirus, which will not only impact China’s economy but could also lead to additional weakness in countries that do business with China or that make products there.

What’s more, while investors have taken a shine to the Fed pump-priming the system with cash - something it was forced to do late last year after deposits by banks held at the Fed grew scarce enough to send the fed funds rate unexpectedly soaring - the central bank's daily lending in the repo market soon will come to an end.

“Clearer communication is needed to allay concerns among investors that an end to building reserves will pull the rug out from under risk assets,” Morgan Stanley wrote in a research note last week.

That communication will come in the form of a press conference by Fed Chairman Jerome Powell following Wednesday’s announcement on interest rates.

Even so, while investors are not expecting any changes at this meeting, they appear to be torn going forward: Based on fed funds futures, the market is currently pricing in nearly 75% probability of at least one rate cut in 2020.