Posted on April 30, 2015

Fed Issues Dovish Statement–Clearly Concerned About The Economy

The tone of today’s Federal Reserve Policy Statement was decidedly dovish as the Fed attributed only some of the slowdown in growth in the first quarter to transitory factors.

Coming in at only 0.2%, GDP growth in the U.S. slowed to a crawl in the first three months of this year. Businesses slashed investments, consumers were cautious, housing slowed and exports weakened. Some of the weakness can be attributed to one-time factors such as bad weather and the West Coast port strike. But the strong U.S. dollar tempered exports and the oil price decline cut production. Wall Street had been expecting growth of 1%.

It has become crystal clear that the Fed will be very cautious in raising interest rates, particularly with tightening fiscal policy and inflation well below target. The Committee also noted that even when they do raise interest rates, they will likely remain well below what the Fed considers to be normal levels for an extended period. Interest rates in the U.S. are actually higher than yields in most other advanced countries, which has led to a surge in foreign buying of Treasurys, especially by Japan.

Japan has now eclipsed China as the largest foreign holder of U.S. bonds for the first time since 2008.

Concern about secular stagnation is a global issue. Several European countries have posted negative 5-year yields in their recent bond auctions—Germany, Denmark, The Netherlands, Austria, Switzerland, Sweden and Belgium. The European Central Bank (ECB) chose to experiment with negative rates before turning to ‘quantitative easing’–a bond buying program used in the U.S. and Japan. The ECB was the first major central bank to venture into negative territory and its deposit rate reached minus 0.2 percent in September, a level President Mario Draghi said was the “lower bound.” It effectively punishes banks that hoard cash at the central bank instead of extending loans to businesses or to weaker lenders.

Sweden is using a similar combination of negative rates and bond-buying. Denmark pushed rates deeper into negative territory to protect its currency’s peg to the euro and Switzerland moved its deposit rate below zero for the first time since the 1970s. Since central banks provide a benchmark for all borrowing costs, negative rates spread to a range of fixed-income securities. By the end of March, more than a quarter of the debt issued by euro zone governments had negative yields. That means investors holding to maturity won’t get all their money back.

The U.S. was supposed to be the engine of growth this year, but so far that hasn’t happened. The Fed has nothing to lose remaining on the sidelines and could well do so for the remainder of this year.