This is What it Sounds Like When Doves Cry

Market Commentary – Summer 2019

When Fed bankers, investment gurus, CNBC talking heads and now, Presidents hold forth on the appropriate interest rate policy we summarize their position as “dovish” or “hawkish”. Doves want to ease the pain of poor financial decisions and support markets by keeping interest rates lower than the economy requires. This prevents layoffs by marginal businesses that couldn’t make it under harsher conditions and extends the business cycle. Not incidentally, it allows Wall Street and its denizens additional time to pawn off marginal equities and bonds to investors before these securities’ faults are revealed in the harsh light of neutral or tight financial conditions. Financial conditions in the U.S. have been set on “easy” since 2008.

Hawks wants monetary discipline to be applied to a chaotic economy and runaway markets in the form of an interest rate that makes business think twice before taking on the risk of financing to build a plant or hire the incremental worker. This keeps precious capital from being wasted on uneconomical projects and instead directs it toward improvements with a payoff greater than the cost of financing. Prudentially hawkish policies can quell excesses, save us from profound risks like the global financial crisis and such frivolities as stocks like

Today, ten years into an economic recovery with the economy growing above trend, employment conditions tight and profits at all time highs, one might expect the hawks to have the upper hand in the discussion regarding policy. However, the doves believe they have a point or two. They cry that the Federal Reserve’s own inflation rate target of 2% has rarely been exceeded during this long business cycle, so where is the risk of easier conditions? They point to leading indicators that presage a slowing economic growth rate. These factors should compel the Fed to lower rates to prevent a possible future recession.

We reckon that the short-term interest rates set by the Fed are still supportively low, if just by a bit. Ideally, the Fed would achieve the elusive neutral rate (a level of interest that neither hurts nor helps the economy) and stay there for a while. This neutral rate provides a higher perch from which dovish rate cuts can be applied in the event of a real future crisis. Recessions are a part of the business cycle. Better a mild recession sooner than a crisis fomented by policy that is too “easy” for too long. Our preferences, however, are largely irrelevant. What matters to our clients is what actually happens.

We believe the Fed will cut rates this year. Certainly, the markets are anticipating such a cut. Such an environment should be good for stocks. Stock prices are rich, but not obscenely so and continued progress seems to be in the cards.  Bonds have had a good 2019 as slowing growth has been priced in. Under more dovish conditions the prospects for growth should heat up, creating challenges for longer dated high-quality bonds. In summary we believe stock exposure should remain close to target for long term investors and that bond portfolios should stay shorter than the market for most investors.


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