Broad market volatility remained elevated in November amid ongoing concerns of tighter monetary policy, U.S./China relations, and the slowdown in global growth that may result from these matters. The U.S. economy continues to grow at an above trend rate, bolstered by tight labor markets and strong consumer spending. At the same time, the current expansion is now at 113 months, the second longest streak since World War II and close to besting the 1990s expansion at 120 months.
It was the worst December for U.S. stocks since the Great Depression, and the outlook for global risk markets remains grim heading into 2019. A great deal of blame for the recent carnage has been placed on the Federal Reserve, particularly from President Trump. If anything, the Fed has been operating under standard central bank procedure according to its dual mandate to this point, but financial markets have become too accustomed to an unofficial third mandate popularized by Fed Chair Jerome Powell’s three predecessors (Greenspan, Bernanke, and Yellen).
The Fed has received much popular criticism for raising the fed funds rate again in December, as Fed leaders resisted pressure to act in support of equity markets.
While markets are focused heavily on Fed interest rate policy, a greater unknown is the impact of quantitative tightening on market performance.
Treasury Secretary Mnuchin's questionable reassurance of bank liquidity roiled markets on Christmas Eve.
Too often, these predecessors would make supportive statements or policy decisions in an apparent effort to boost asset valuations during periods of heightened market volatility. These actions were initially dubbed the “Greenspan put” in the 1990s, and hence, the assumption of a third mandate. In 2011, Fed Chair Ben Bernanke boasted in his belief that Fed asset purchases “have contributed to a stronger stock market, just as they did in March of 2009” following the initial round of quantitative easing. Under Janet Yellen’s leadership, the Fed was also reluctant to raise rates until late in her term.
The problem with this “third mandate” is that it increases financial instability risks, as evidenced by the dot-com and housing bubbles of the 2000s. Fed Chair Powell seems to understand this dilemma, and his determination to continue with policy tightening in the face of volatile risk markets is commendable from this perspective. Business cycles must come to an end, and the current expansion is close to becoming the longest in history (and already well above average in terms of duration).
Powell is not inexperienced whatsoever as it relates to financial markets and expected reactions. He has been an investment banker, hedge fund manager, and held numerous posts within the Treasury Department. It would seem that he is trying to lead the Fed down a prudent path given its assessment of current economic output and completely independent of market volatility and outside criticism, particularly from the executive branch. This should be a welcomed event from the many who have criticized previous Fed administrations of fueling asset bubbles. Will Fed tightening ultimately be followed by an economic recession? If yes, it would be consistent with almost all other Fed tightening cycles, but the severity of a recession can be amplified by the bursting of major asset bubbles, which most market participants fail to see until it’s too late. This is precisely why those who have criticized the Fed for contributing to past bubbles should be applauding Powell for not wavering in the face of these pressures.
This market overview is provided by ALM First Financial Advisors, LLC, the investment advisor for Trust for Credit Unions. Read more from ALM First about the latest economic data releases and overall market trends at Trustcu.com.
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