- Financial markets experiencing ‘tug of war’ over path of monetary policy
- Monetary policy influences many parts of the economy, including stock prices, mortgages and spending
- Over the past 18 months, we believe we’ve seen competing monetary policy views play out in real time
- The current economic cycle has become the longest on record; cycles don’t end because of ‘age’
- Don’t get caught in the middle of competing market views – maintain a disciplined investment approach
Tug of war – a popular game of strength in ancient Greece, children’s summer camps, and… financial markets? Well, maybe not exactly, but as investors, there are times it can feel like we’re being pulled in opposing directions by competing ‘teams’- stock market bulls vs. stock market bears, economic growth forecasters vs. recession tea-leaf readers and, most recently, expansionary vs. restrictive monetary policy debaters.
Monetary policy simply refers to action taken by the Federal Reserve to promote stable prices and maximum employment. Policy is such an important consideration to financial markets, because it has the ability to indirectly affect or influence many things, such as mortgage rates, exchange rates, stock prices, household and business spending, and inflation. When the Federal Reserve decides to implement a policy change, it typically does so by adjusting short-term interest rates to change the cost and availability of credit in the economy. Low (or falling) interest rates are generally considered expansionary, while high (or rising) interest rates are considered restrictive.
Over the past 18 months, we believe we’ve seen the push and pull of competing monetary policy views play out in real time. The chart below displays the S&P 500 index level (green line, left axis) vs. the average economist forecast for 2019 interest rates, compiled from the Wall Street Journal Economist Forecasting Survey (blue line, right axis). Here, note the divergence between the two lines, depending on the prevailing policy view – most noticeably from January 2018 – June 2018 where expectations for more restrictive policy prevailed and subsequent declines in the S&P 500 occurred compared to 2019’s S&P 500 advancement coinciding with greater expectations of more expansionary policy.
As we enter July, the current economic growth cycle will become the longest on record. This can give some investors pause, especially when you add mixed economic data and changing monetary policy expectations. Yet, economists like to say that economic cycles don’t ‘die of old age’. Perhaps the best example of this is Australia. The Commonwealth hasn’t experienced a recession since the early 1990’s, effectively side-stepping the 2008 global slowdown, and has changed monetary policy numerous times during their nearly 30-year economic growth cycle.
Over the coming quarter, the market will likely be anticipating numerous events, including a highly anticipated Federal Reserve meeting at the end of July where an interest rate cut is expected. Regardless of whether or not a rate cut occurs, there will likely be plenty of fodder to support competing market views. The key for investors will be to keep from getting caught in the middle of a market tug of war and to maintain a disciplined investment approach.