The Fed thinks the US economy stinks. Markets are thrilled!

Cheer up, Chairman—the markets love you.
Cheer up, Chairman—the markets love you.
Image: Reuters/Jonathan Ernst
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Remember back in September 2018, before markets went haywire and the Chinese economy started looking extra-shaky? In those sunnier days, even the chary folks of the Federal Reserve saw good times ahead and predicted the US would grow a solid 2.5% (pdf) in 2019.

How quickly minds can change.

Fed officials now forecast a measly 2.1% growth this year, according to their announcement (pdf) today (March 20).

That’s a lot less than what the Trump administration has promised, or what the IMF projects.

And—despite the glum forecast—markets could hardly be more thrilled. The 10-year Treasury rallied 3.3%, to the highest price of this year, on the Fed’s announcement, while the S&P 500, Dow and Nasdaq all climbed on the news. That’s because the bad news was delivered with a big spoonful of sugar: The Fed signaled it won’t raise interest rates this year.

Time was, rising prosperity of workers and firms drove financial markets. No longer. Markets don’t need anything so worldly as economic growth to fly higher these days.

Since the 2008 financial crisis hit, asset prices everywhere have been borne aloft on a huge, seemingly endless updraft of central bank money supply. This has gone on so long that those prices are now like skydivers in a wind tunnel. The only thing between them and a hard crash back to the ground is central banks cranking out more and more fake wind.

This gets to the reason markets are so darned psyched that American growth might be sputtering. Unlike its other major central bank counterparts in Europe and Japan, the Fed has been turning down the wind speed: raising interest rates and selling down the colossal pile of securities it amassed during quantitative easing (when it bought bonds and other securities to pump more money into the financial system, effectively pushing rates below zero). Particularly under current head Jerome Powell, the Fed embraced big plans for making money less fantastically cheap than it had been post-crisis, bringing financial conditions to something approaching normal (not that anyone is really all that clear what, exactly, normal is anymore).

Weirdly, it took a while for investors to clock what was going on.

But finally in the fall of 2018, they did. There’s no way you missed the market freak-out that resulted. The Fed, obviously, didn’t either. What’s likely been worrying Powell and his peeps more, though, is that, amidst all the panic, financial conditions in the US tightened a lot. And since a decade of the cheapest credit possible has suffused the American economy with debt, the tightening of financial conditions —which made borrowing costs more expensive—increased the chances that businesses would pull back investment or even start to default on payments—the makings of an ugly recession.

No one wants that on their hands. And surely enough, the Fed reversed course. In January, it embraced “patience” as its new approach to hiking (or rather, not hiking) rates.

Well, patience is here to stay. In tandem with it newly gloomified 2019 growth outlook, the Fed is both keeping rates low and halting the sale of those QE-created holdings.

In other words, it’s not cranking up the fake wind yet. But as investors were evidently delighted to learn, neither is the Fed planning anymore on cutting it.