Summary for the 5th of February 2019

After the stock market last year had a biggest decline since the Black Monday in 1987, the Federal Reserve has been reconsidering its monetary policy. The Chair of the Federal Reserve, Jerome Powell, has repeatedly said that the Fed will be more patient about setting the target rate. The economic indicators will be the determining factors for whether the Fed is changing target on the benchmark rate or not. This was confirmed on the last Federal Reserve rate decision and at the press conference last week.

One of the reasons the Fed will be patient is the inflation rate. The core inflation rate is close to Fed’s objective of 2 percent and with a low risk of a sudden rise in inflation, The Fed can hold off the rate hike longer. Though, the average hourly earnings are rising which will lead to rising prices/inflation rate. The Federal Reserve Board has said that it will accept an inflation rate a little over 2 percent objective.

The other reason for a more patient in determining a rate hike is the fact that the market interest rates are closing to the normal level. The normal level for the interest rates is important, the difference between the target rate and the normal level will tell how the monetary policy is affecting the economy. When the target rate is lower than the normal level, the policy is expansionary, it fosters economic growth. When the difference is getting smaller, the policy is less expansionary on the economic activity. For now, the Fed is considering the monetary policy as expansionary, because the target rate is lower than the normal level. This normal level varies, but the median level given by the members of the Federal Reserve Board is at 2.8 percent.

The effect of a rate hike doesn’t show immediately. The market will adjust to the rate hike immediately, but the effect on the real economic value will show after some time has passed. The reasons are due to many consumers and companies have a fixed rate agreement with their lenders. When these consumers/companies getting new loans or refinancing their current loans, the effect of a rate hike will start showing, and due to many US companies have a high level of debt, the effect will thus be strong once it is realized. The combination of a slow but strong effect from rate hikes makes the Fed more careful when setting the target rate.

The Fed is also going to slow down the rate of which it is reducing the size of its balance sheet. Last year, the Fed was reducing its balance sheet by 50 billion dollars each month. Combined with a strong dollar(currency) and a slow growth in balance sheets from other major central banks, had led to high volatility in the financial market in 2018. The Fed is now reconsidering the normal level of its balance sheet, this level can be higher than it was originally planned. After ten years of the unconventional monetary policy, the financial market has been accustomed to high liquidity from the Fed. If this liquidity is cut too much too soon, the consequences could be unintentional effects on the economy.

Indices on 5th of February: Positive earnings from US companies and a signal of low long term rates had given the US stock markets a positive close. Nikkei closed in negative due to weak PMI numbers from the service sectors.

Dow: +0.7% (4^th of February )

S&P 500: +0.7% (4^th of February)

Nasdaq: +1.2% (4^th of February)

Nikkei: -0.2% (5^th  of February)

Chinese indices: Closed (5^th  of February)

STOXX Europe 600 Index: +1.41% (5^th  of February)

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