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Patience is a virtue

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      By Eric Stein, CFA, Co-Director of Global Income, Eaton Vance Management

      Boston - In my last blog post earlier this month, I wrote about how the Federal Reserve reversed course to a more dovish tack. This week's FOMC announcement and press conference with Chairman Jerome Powell show the Fed has continued with its dovish communication plan, and solidified its message that monetary policy is on a very different course than it was at the December meeting.

      There was a strong market reaction to this on Wednesday, with equities higher, the U.S. dollar weaker and the U.S. Treasury curve steeper, with front-end yields leading the way lower. In particular, the Fed's dovishness so far in 2019 seems to have given investors the green light to buy emerging market assets. If anything, yesterday's announcement has accentuated this message.

      On Wednesday, the Fed held its target rate steady and communicated flexibility and patience. The Fed removed the longstanding language about further gradual hikes and also indicated it would be open to adjusting the balance-sheet normalization plan.

      To me, this is all very consistent with the change in tone that started in the beginning of 2019 with Powell's talk at the American Economic Association (AEA) conference, and continued with similar commentary from many other Fed officials. In particular, Powell is continuing to walk back his comments at the December press conference that so unnerved markets.

      The Fed hiked in December as expected, but markets were laser-focused on Powell's comments that the pace of Fed balance-sheet normalization was on "autopilot." As I a wrote in December, Powell seemed tone deaf to tightening financial conditions in late 2018, including a flattening Treasury yield curve, widening credit spreads and declining inflation expectations.

      While there has been some market chatter in recent weeks about the Fed's thinking becoming more flexible on the balance-sheet normalization process, the Fed's announcement solidified that view and was likely a big driver of the moves we saw in financial markets on Wednesday afternoon.

      Of course, the question now is what's next. Regarding future hikes, is this a pause, or a stop? If the economy continues to perform well, it will be a well-timed pause, and if it doesn't, it will be a stop. To me, what is particularly encouraging is that in stark contrast to the December FOMC meeting, the Fed appears to following the "First do no harm" edict that is commonly associated with the Hippocratic Oath in medicine (though technically it wasn't actually part of the oath). For me, this change in tone is a very positive one for financial markets and will give the Fed a lot of flexibility in the future over whether the next move could be hike, a cut, or if we could be on hold for a while.

      Another key change to the Fed statement is that officials acknowledged that inflation expectations have moved lower in recent months, which provides further cover for standing pat on hikes. In fact, if inflation were to pick up substantially from here, that would be something that could sway the Fed off its new dovish done.

      Bottom line: The Fed announcement yesterday was very consistent with its dovish communication so far in 2019. Barring an unexpected increase in inflation, the Fed's newfound dovishness should provide a great backdrop for many risk-assets, particularly emerging market assets.