Powell gives equity bulls all they need

31 January, 2019

Have we reached the end of the tightening cycle?


The Federal Reserve has taken a 180-degree turn. After raising interest rates four times in 2018, the Fed said it would be patient as it determines what future adjustments to the target range of the federal funds rate may be appropriate.

The key words here are ‘patient’ and ‘adjustment’. Patience suggests that the Fed might be done with tightening policy in the short run, meanwhile adjustment means interest rates may go either up or down.

Although markets have been anticipating a dovish Fed, what was delivered on Wednesday was beyond expectations. As a result, the Dow Jones Industrial Average surged 435 points, the yield curve steepened, and the Dollar fell against its major peers.

Key changes to the Fed statement


In addition to the patience approach, the Fed is no longer on autopilot mode for reducing its balance sheet. The central bank stated that it is now prepared to adjust any of the details for completing balance sheet normalization in light of economic and financial developments.

Although the Fed continues to see economic activity remaining healthy, it has downgraded its overall assessment of economic activity from ‘strong’ to ‘solid’.

Green light to take risk?


From an equity valuation perspective, the required rate of return has been pulled lower for now, suggesting that further gains may be in the cards. However, this component is not enough to provide a sustainable rally to equity markets. A weakening global economy, the U.S.-China trade conflict, Brexit, and other geopolitical factors will continue to challenge risk appetite.

In short, the shift taken by the Fed is of great relief to equity bulls, but other factors need to be resolved in order for the bull market to be sustained.  

Gold shines again


A dovish Fed, lower bond yields and a weaker Dollar are key ingredients for higher gold prices. However, it seems the yellow metal is also seeing a boost from central bank purchases. In its most recent report, the World Gold Council stated that central banks added 651.5 tons to official gold reserves in 2018, creating the second highest annual total on record. If this trend is expected to continue in 2019, the chances of retesting the 2016 peak of $1,375 is highly likely in the coming two months.


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