Chief economist update: The Fed pause that refreshes

You couldn't miss it even if you tried; the S&P 500 index and the Nasdaq Composite Index surpassed their former peaks overnight. And the Dow is not far behind - it's off a mere 0.6% away from its all-time high.

Yes Virginia, you can be forgiven for scratching your head, for it was just a month ago that fears of an upcoming US recession was the spook du jour portended by the inversion of the US yield curve.

Since then, the yield curve has become positive, the VIX index - or the fear gauge - has come down and now US equities are on the up and up.

Suddenly, diktats to the Fed earlier this month by Trump - "In terms of quantitative tightening it should absolutely now be quantitative easing" - and White House economic adviser Larry Kudlow - he wants the Fed to "immediately" cut interest rates by 50 basis points - ring hollow.

The pause that refreshes. The Fed's forward guidance of a pause was sufficient to lift the animal spirits among equity investors.

It reaffirmed this in the minutes of its 19-20 March FOMC meeting.

"With regard to the outlook for monetary policy beyond this meeting, a majority of participants expected that the evolution of the economic outlook and risks to the outlook would likely warrant leaving the target range unchanged for the remainder of the year," the Fed said.

As Louis Armstrong sang, "I see trees of green, red roses too".

Not only that, a listing of US news by Trading Economics counts the number of improving stats in America:

  • US New Home Sales Jump to Near 1-1/2-Year High
  • US Housing Starts Fall to Near 2-Year Low in March
  • US Manufacturing Growth Holds Steady at Near 2-Year Low
  • US Retail Sales Post Biggest Gain in 1-1/2 Years
  • US Jobless Claims Drop to Fresh Low since 1969
  • US March Budget Gap Smaller than Expected
What immediately came to my balding head was ... will the Fed do a China? Beijing has reverted back from stimulating activity to "reform and opening up" and "restructure" of the economy.

The Fed now has the excuse it needs to justify a resumption of its normalisation of monetary policy.

Just as I expected, the CME FedWatch Tool now shows that the probability of a Fed rate hike in June this year to 2.5%-2.75% has increased from nil a month ago to 0.4%.

No one would bet their house on these odds but the fact remains there are now investors pondering the Fed's return to policy normalisation.

In case you missed it, the minutes of the Fed's March meeting also contained a caveat: "Several participants noted that their views of the appropriate target range for the federal funds rate could shift in either direction based on incoming data and other developments."

"Some participants indicated that if the economy evolved as they currently expected, with economic growth above its longer-run trend rate, they would likely judge it appropriate to raise the target range for the federal funds rate modestly later this year."

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