Filed under: Forecasts, Market matters, Economic data, Headline news, Federal Reserve

The Federal Open Market Committee (FOMC) reduced interest rates by a quarter of a percentage point, taking the target Federal Funds Rate to 2% and the Discount Rate to 2.25%, as expected. However, the indication of at least a pause in interest rate cuts wasn’t present. On the contrary, the Fed maintained its dire view of the economy mentioned in the March statement. The only positive indication that it gave was dropping the sentence “However, downside risks to growth remains.” Two FOMC members voted against the rate cut as they did previously during the March meeting.

The stock market, which had been up by as much as 1% prior to the Fed announcement gave back all the gains and shut slightly down. Gold closed up slightly, and the dollar closed down.

What were the reasons that the Fed maintained this position and didn’t indicate a pause?

First, the Fed still believes that there’s still substantial risk in the economy and further rate cuts could be necessary. There have been several positive economic and earnings reports lately and the stock market has drifted higher. If the Fed had signaled a pause, it may have been concerned that this could indicate an all-clear signal and ignite a rally. Negative news in the future and additional rate cuts might then be interpreted negatively. This could trigger a steeper falloff, increasing volatility. The Fed decided to take a cautious approach and manage investor expectations.

The Fed also didn’t want to risk endangering its new-found credibility. If the Fed indicated a pause and then was forced to reverse itself, it would appear as if it was not in control of the situation. This was the case before the current set of rate cuts put to rest the notion that the Fed was behind the curve.

The negatives produced by leaving out the pause were relatively minor. The dollar weakened, slightly increasing inflationary pressures. However, a weaker dollar also helps exports which are the main positive area in the GDP report this morning.

What does this mean for the investor? As long as inflation remains at close to current levels, this means that we’ll still be in a negative interest rate environment (short-term Treasury rates less than the rate of inflation). This forecasts some type of a small-cap rally in the future. However, the fear present in the lending environment will have to recede first.

Doug Roberts is the Founder and Chief Investment Strategist for ChannelCapitalResearch.com, and is the author of Follow the Fed(R) to Investment Success: The Effortless Strategy for Beating Wall Street. He previously held executive positions at Morgan Stanley Group and Sanford C. Bernstein & Co.

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