After the fed revised GDP growth forecasts down, inflation forecasts up, and kept their rate cut forecasts the same, markets jumped up – experts explain why
With the S&P 500 shedding most of its post-election gains this month, US GDP growth beginning to slow down, and inflation expectations in the world’s largest economy rising the US Federal Reserve took the decision to hold its interest rates steady and maintain its outlook of two 25 basis point cuts this year. They did so despite revising US economic growth forecasts for the year down to 1.7 per cent while raising their inflation outlook to a 2.8 per cent annual pace. The central bank seems to see a growing risk that the US enters a stagflation scenario.
Despite that troubling forecast, both fixed income and equity markets greeted the Fed meeting warmly in the hours following the announcement. Experts outlined how the potential for an even more hawkish stance as well as the slightly dovish decision to reduce quantitative tightening played a role in those market moves. They highlighted the importance of the next round of tariff decisions set for April 2nd and how advisors can help navigate this uncertain environment for their clients.
“There’s still a huge unknown coming on April 2nd when reciprocal tariffs are set to be implemented and, truly, the Fed doesn’t know what’s going to play out there,” says Chris McHaney, EVP and head of investment management and strategy at Global X Canada. “I think it makes sense, from their perspective to stay the course this time. We'll see how these tariffs start to play out, if that is going to significantly affect growth more or less than they thought and if they’ll make a move in the coming months.”
The market reaction immediately following the Fed decision surprised McHaney somewhat, simply for how positive it has been. Two-year yields fell by more than 10 basis points, which he described as a ‘very big move’ and likely caused by the Fed’s announcement that they would slow the pace of their quantitative tightening. He notes, too, that the market might have been pricing in the likelihood of a more hawkish tone from the Fed. The fact that Powell sounded more neutral was therefore greeted a bit warmly.
Tom Nakamura highlighted just how much uncertainty appeared baked into the Fed’s outlook and decision. The VP & Portfolio Manager for currency strategy and co-head of fixed income at AGF Investments Inc. sees the Fed as now poised to react to changes in data, rather than front-running possible decisions from the White House.
Uncertainty about trade policy, however, will start to have impacts on the US economy even if final decisions about tariffs have not been arrived at yet.
“I think that uncertainty alone starts to weigh on the economy. I think you're already seeing signs of that, in business planning and sentiment,” Nakamura says. “We know that, and it can start to impact consumer behaviour, if people aren't sure what kind of tariffs we’re going to see then they might start making different decisions.”
McHaney agreed with that outlook noting that the ongoing cycle of tariff threats followed by deals has introduced a dynamic where economic actors now just want to know with certainty whether tariffs will be in place on US imports or not.
Among those immediate impacts has been an increase in inflation expectations among US consumers. While the Fed has revised its own inflation expectation upwards, Nakamura notes that Powell described tariff-induced inflation as likely “transitory,” a term previously used to describe the start of the historically high inflation seen in 2022. That may have signalled to markets that the Fed may be more focused on growth than inflation going forward.
Both Nakamura and McHaney identified a few areas of possible opportunity for investors amid this uncertain environment. McHaney notes that US equities might still be a bit expensive even after their correction. However on the fixed income side he sees returns in a shift towards the shorter end of the curve. “keep away from that duration risk and that volatility if you have been there, lock in the gains you're seeing and move to the short end and keep clipping those higher yields,” he says.
Nakamura agrees that government bonds, treasuries or otherwise, might look attractive right now. Inflation-protected securities, too, might be poised to do well if the Fed starts discounting inflation risks. Credit, too, might be able to reverse its recent underperformance if the US manages to avoid a recession. He caveats that outlook with the notion that everything could change with the next Truth Social post from the White House.
While markets breathed a sigh of relief following the meeting, uncertainty remains the watchword for investors. Nakamura notes that with this uncertainty may come opportunity for those able to see it.
“As much as this volatility is so very challenging, i think if we take a long-term perspective, and we get more extreme moves, they do will present us with opportunities,” Nakamura says. “So whether it's just an entry point into the stock market, whether it's opportunities to be more global, whether it's going into places like floating rate notes or inflation protected securities or anything like that. You have to work through the investment rationale and think long term, but usually those opportunities are there.”
