Multi-Asset

Monetary policy is "likely to remain appropriate"

In line with market expectations, the Federal Reserve (Fed) cut its policy rate by 25bp in October, the third 25bp rate cut since July.
November 2019
  • Fed cut rates by 25bp in October, the third consecutive cut. U.S. economic growth has cooled this year while outside risks continue to cloud the outlook. But additional cuts will depend upon future data.
  • The BoC left rates on hold, but sounded surprisingly concerned about the global slowdown although there is limited evidence of contagion to Canada. In sharp contrast to Governor Poloz, Fed Chair Powell sounded more optimistic on the global outlook.
  • In our base case of growth stabilization, we expect the Fed to remain on hold but with risk skewed for more easing. The bar for easing has been lowered in Canada. With inflation on target, continued labour and housing market strength, and a Fed on hold, we continue to expect the BoC will lag the Fed this cycle.
  • We believe monetary policy should continue to be supportive of our equity overweight and preference for U.S. and Canadian equities.

Monetary Policy is “likely to remain appropriate”

In line with market expectations, the Federal Reserve (Fed) cut its policy rate by 25bp in October, the third 25bp rate cut since July. Prior to the meeting, various Fed members cited weaker economic data as well as outside risks to the outlook, including the US-China trade war and Brexit. Negative external developments could require more cuts. Importantly, the Fed dropped the statement that it will “act as appropriate to sustain the expansion” while signaling that additional cuts will be dependent upon future data releases.

For Canada, we think the odds of a recession are slightly lower given that i) we continue to think the country is less exposed to trade disputes, ii) the housing market is responding to lower mortgage rates and iii) that Canada has the fiscal capacity to safeguard the economy from a recession. We think the odds of a recession in Canada are less than 20% for the next 12 months, with the downside mainly driven by global factors.

What’s next for the Fed?

The Fed will continue to be data dependent with a focus on manufacturing and business data especially.  However, Chairman Powell made it clear the current state of monetary policy is “likely to remain appropriate.” Markets now do not expect the next rate cut until well into 2020, with those expectations having been dialed back over the last few weeks as the bar for additional cuts has been raised higher. However, long-term Treasury yields fell sharply after the Fed decision as investors remain skeptical of the Fed’s policy path. Trade negotiations will continue to influence Fed policy, but easing trade tensions with scope for a “mini” China deal would leave the Fed on hold.

Unsurprisingly, the Fed’s dot plot – intended to convey the members’ interest rate expectations – are higher than rates implied by investors, suggesting the market has a more bearish view on the economy than the committee. However, there is significant dispersion in the dots, displaying the differing views within the Fed. The growing rift within the Fed suggests a more flexible approach but also risks confusion in communicating monetary policy to the market, a potential recipe for heightened market volatility.

Bank of Canada: “Canada’s resilience will be tested”

The Bank of Canada (BoC) left rates unchanged, but surprised investors by sounding increasingly worried about the global slowdown and the risk of contagion to Canada, blaming it heavily on trade tensions. This anxious tone conveyed by Governor Poloz lowered the bar for easing. Following the BoC’s policy decision, investors were calling for a third of a chance for a December cut, from a nearly zero chance the prior day. However, with inflation on target, a tight labour market and a housing market that’s rapidly heating up, the easing thesis remains weak, especially if the Fed is done with cuts. More importantly, as long as the Canadian economy chugs along, we continue to expect the BoC to lag the Fed in its policy response in this cycle.

Implications for Asset Allocation

We continue to believe the U.S. economy will withstand this temporary slowdown, especially considering the Fed’s willingness to extend the cycle. Though the Fed’s decision sounded more balanced than previous meetings and we still believe the Fed stands ready to act as needed if data deteriorates, Powell made it clear it would take a substantial change to their outlook to merit another cut. In our base case of growth stabilization, which was supported by a strong non-farm payroll report on November 1st, we would expect the Fed to remain on hold but skewed dovish, especially with inflation a secondary concern. For these reasons, we believe global monetary policy should continue to be supportive of our equity overweight and preference for U.S. and Canadian equities.

This article is for information purposes. The information contained herein is not, and should not be construed as, investment, tax or legal advice to any party. Investments should be evaluated relative to the individual’s investment objectives and professional advice should be obtained with respect to any circumstance.

This commentary has been prepared by BMO Asset Management Inc. the portfolio manager. This update represents their assessment of the markets at the time of publication. Those views are subject to change without notice as markets change over time.

Any statement that necessarily depends on future events may be a forward-looking statement. Forward-looking statements are not guarantees of performance. They involve risks, uncertainties and assumptions. Although such statements are based on assumptions that are believed to be reasonable, there can be no assurance that actual results will not differ materially from expectations. Investors are cautioned not to rely unduly on any forward-looking statements. In connection with any forward-looking statements, investors should carefully consider the areas of risk described in the most recent simplified prospectus.

BMO Global Asset Management is a brand name that comprises BMO Asset Management Inc., BMO Investments Inc., BMO Asset Management Corp., BMO Asset Management Limited and BMO’s specialized investment management firms.

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