This past Wednesday, the Federal Reserve cut its discount rate by ¼ of a percentage point, in line with market expectations. In my view, a driving factor behind the Fed’s decision to cut rates was the soft economic conditions outside of the U.S., and in particularly the growing prevalence of European bonds trading at negative rates. These conditions are likely to pressure the U.S. dollar, as many investors will employ a ‘carry trade’, where they sell their Euros and buy dollars to invest in Treasuries. This will have the result of driving up the value of the dollar and correspondingly make U.S. exports more expensive. I believe the Fed sees a stronger dollar as an additional risk to the economy.
Market uncertainty increased late last week after President Trust announced a 10% tariff hitting an additional $300 billion worth of Chinese imports on September 1st. If the tariff takes effect, it will likely hamper China’s economy, impact its trading partners, and potentially lead to greater monetary stimulus abroad. These actions alone may force the Fed to act once again to help in protecting the dollar from getting too strong.
With the widely expected ¼ rate cut now behind us, looking forward there is greater uncertainty around future fed actions. I view uncertainty as an opportunity. Less agreement among market participants should lead to higher volatility and lower correlations; two ingredients that create attractive long-term investment opportunities. We have been living in a world of low volatility for some time and the ‘v’ word is often viewed in a negative context. However, volatility occurs on the upside and the downside. And while downside episodes of high volatility are challenging to go through, they often lead to opportunities on the other side.
At Telemus, client portfolios have been positioned for the expectation that we will go through a period of higher volatility. This won’t entirely insulate client from volatility, but we are aiming for a ride that is less bumpy than the market in general.