What’s behind the market reaction to Powell’s comments on quantitative tightening?

On the latest edition of Market Week in Review, Chief Investment Strategist Erik Ristuben and Research Analyst Brian Yadao discussed market reaction to the U.S. Federal Reserve (the Fed)’s latest interest-rate increase, the impacts of a potential U.S. government shutdown on markets and volatility projections for 2019.

Markets sink in wake of Powell press conference

In a widely-anticipated move, the Fed announced another interest-rate hike on Dec. 19, raising the benchmark lending rate to a target range of 2.25% to 2.50%. Market reaction was initially fairly muted, but remarks by Chair Jerome Powell during a follow-up press conference quickly sent stocks tumbling. Why?

“Responding to a question about quantitative tightening, Powell said that the Fed’s balance sheet runoff is on autopilot—and that really seemed to spook investors,” Ristuben said, adding that he found the strong reaction somewhat surprising. “Both Powell and former Fed Chair Janet Yellen have previously talked about shrinking the balance sheet (by up to $50 billion a month) in automatic fashion,” he noted.

Powell’s comments probably touched on a primary issue for markets, Ristuben said: concern that the Fed is striking too hawkish of a tone at a time when the growth of the U.S. economy and corporate earnings appear primed for a slowdown. “At Russell Investments, we anticipate that GDP (gross domestic product) growth rates will slow from roughly 3% this year to closer to 2% in 2019, as the impacts of tax cuts and fiscal stimulus fade.” Earnings growth among U.S. companies, Ristuben believes, will probably lower to somewhere in the single-digits—a big drop from the roughly 25% growth rates observed earlier this year.

“At the end of the day, the market is really struggling over whether or not 2019’s forecasted slowdown will be the start of a recession,” he said, “and that’s made it extra-sensitive to all kinds of news.”

Impacts of a U.S. government shutdown on markets

With a partial shutdown of the U.S. government a possibility beginning Dec. 22, markets are likely to experience a renewed dose of volatility, Ristuben said. However, he emphasized that, in the end, a shutdown is unlikely to have a lasting impact. “What the market really cares about most is how the U.S. economy is holding up, versus any headlines coming out of Washington, D.C.,” he remarked. With a divided U.S. government looming come January, shutdowns may also become more common going forward, Ristuben noted.

2019 outlook: More volatility ahead?

The week of Dec. 17 was a particularly bad one for equities, especially in the U.S., Ristuben noted, with the Russell 1000® Index dropping nearly 7% on the week (as of mid-morning Pacific time, Dec. 21). By contrast, in the same timeframe, the MSCI EAFE Index—which measures the performance of developed markets outside of the U.S. and Canada—was down only 3.3%, while the Russell Emerging Markets Index was off approximately 2.3%.

“This shows that the weakness in the stock market is really about the U.S.—and increasingly, about recession risks in particular,” Ristuben explained, “as the current U.S. economic expansion is just over six months away from becoming the longest on record.”

So, how might 2019 unfold? “It will likely be a year marked by plenty of market volatility and smaller returns,” he said, emphasizing that a cautionary approach may be the way to go.

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