As U-turns go, Jay Powell’s is right up there. The Federal Reserve chairman yesterday performed a spectacular reverse ferret on the trajectory for US interest rates. And the markets loved it.
You don’t have to be a central bank geek to recognise the difference between his comment yesterday that monetary policy is now ‘just below’ neutral and October’s assessment that ‘we’re a long way from neutral at this point’.
A month ago, he was telling the market that the Federal Reserve was likely to continue raising interest rates by a quarter point every three months throughout 2019. Now he is hinting that December’s hike may be nearly the final act in the central bank’s tightening cycle.
This is a big deal for markets because rising interest rates are one of the biggest clouds hanging over investors as we all gaze into our 2019 crystal balls. Stock markets dislike rising interest rates because they increase the cost of borrowing for companies and leave individuals with less money to spend.
If the Fed is really close to ending its three-year-long monetary squeeze then the long post-crisis bull market may have a bit further to go. It would not be surprising if Mr Powell has fired the starting gun on the Santa Rally this year.
Unsurprisingly, the S&P 500 enjoyed its best day since March yesterday, closing 2.3% higher at 2,744. The Dow Jones Industrials index did even better, rising by 2.5% while the tech-heavy Nasdaq rose by nearly 3%.
Other markets around the world also benefited, in part because Mr Powell’s comments helped push the dollar lower. The strength of the US currency in 2018 has been a major contributor to the stresses in emerging markets and any sign that the dollar will weaken from here takes the pressure off stock markets around the world.
It would be wrong to get too excited, however. What Mr Powell said this week changed things, but only at the margin. He suggests we may be closer to reaching a neutral level of interest rates, at which they neither restrain nor stimulate the economy. What he studiously did not say, however, was how far above neutral the Fed may be obliged to raise rates to rein in inflation as the US economy grows at more than 3% and US unemployment falls to its lowest level in 50 years.
The Federal Reserve’s job is to worry about controlling inflation and maintaining financial stability. It is less interested in the level of the stock market so it would be wrong to think that Mr Powell has responded to October’s market wobble and will do the same again if share prices fall once more.
However, it does look like the Fed is beginning to worry - along with the rest of us - about a slowdown in the housing market, the fall in the oil price and the threat posed by the escalating US-China trade war.
If the economy does roll over in 2019 then we should expect the Fed to respond accordingly. We have probably seen the worst of this rate-hiking cycle.
What does this mean for our investments? Hopefully, it will help to stabilise markets at the end of a really difficult year in which, unusually, almost all assets have fallen together. 2018 has been a tough period to be an investor because the gradual withdrawal of stimulus has created headwinds for both bonds and equities, while slowing growth and trade fears have hit commodities. Property has suffered from the ongoing shift from the High Street to online retailers - shops are a major component of many property portfolios and values are plunging.
So, 2018 tested the benefit of diversification to destruction. In 2019, I expect a balanced approach to make more sense again. In an unpredictable market environment, there has never been a better time to spread your eggs around multiple baskets.
The Fidelity Select 50 Balanced Fund aims to provide a smoother ride for investors by splitting its assets roughly 50% in shares and 50% in more defensive assets like bonds and cash. Using the Select 50 list of our preferred funds as its main hunting ground, it is also focused on investing in only the best managers. In the year ahead, that might well feel like a reassuring combination.
The value of investments and the income from them can go down as well as up, so you may get back less than you invest. Overseas investments will be affected by movements in currency exchange rates. Select 50 is not a personal recommendation to buy or sell a fund. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.