This Week in the Markets: 

 

Dovish Fed

• The U.S. Federal Reserve (Fed) left its policy rate unchanged and scaled back its economic assessment last week, delivering on a widely anticipated tilt toward a more dovish setting. The central bank’s growth outlook was chopped by 0.2 ppt for each of 2019 and 2020, the unemployment rate forecast increased by 0.2 ppt and the inflation forecast fell by 0.1 ppt.
• However, the full extent of the Fed’s dovish pivot was more substantial than expected, contributing to materially lower bond yields. Two changes in particular were noteworthy.
• First, the Fed’s “dot plots” – the individual anonymous forecasts from all 17 FOMC participants for the year-end Fed funds rate – retreated more substantially than expected. Whereas the market and we had expected the median forecast to decline from a prior prediction of two hikes in 2019 to just one hike, the median forecast actually fell all the way to an unchanged policy rate for 2019.

Inverted curve

• The U.S. three-month bill to 10-year bond curve just inverted, meaning that the government three-month yield is now slightly higher than the government 10-year yield. The two-year to 10-year curve remains positively sloped for the moment, but only barely.
• This is an important development, as an inverted yield curve has served as a reliable predictor of U.S. recessions for several decades. The logic behind this is that bond yields can be thought of as a proxy for growth expectations over the relevant period. So if the market is looking for less growth down the road (10-year bond) relative to the current growth outlook (three-month bill), that signals a decelerating economic trajectory that frequently culminates in recession.

Mueller

• The full Mueller report itself is not yet public, but the main revelation so far is that the alleged conspiracy between Russia and the Trump 2016 presidential campaign was not proven.
• This comes as somewhat of a surprise given the Mueller probe’s 2,800 subpoenas, 500 witnesses and 34 indictments.
• Furthermore, Mueller opted not to rule on obstruction of justice claims. This leaves the matter in the hands of the Department of Justice, which has opted not to prosecute along this line.

Canadian budget

• Here are two quick observations on last week’s Canadian federal budget:
• First, there isn’t much for investors or business – taxes were largely unchanged and no major improvements were made to the competitive environment. The taxation of stock options became somewhat less attractive for all but startups. On the other hand, small businesses may find it easier to access R&D incentives.
• Second, to the extent it is a spending-oriented budget, the entirety of that enthusiasm was enabled by faster-than-expected revenue growth in 2018-2019 and the assumption that this larger revenue base will persist into the future, rather than particularly fast spending growth penciled in for the next several years. In fact, projected nominal spending growth over the next five years is just 3% per annum. Of course, future budgets may yet depart from that plan