A harsh financial winter blew in over the fourth quarter, especially in December, as investment
markets were whipsawed by investor concerns regarding slowing global growth, trade deterioration,
and policy uncertainty. Volatility as measured by the Cboe VIX Index registered a sustained gain
– closing above 30 for four days – which further dampened the mood of investors who faced
a liquidity constrained environment at year-end. Overall, the final quarter of 2018 was one of
re-priced expectations, as the defining feature of this cycle – central bank support – continued
to be withdrawn. In the ninth such move since 2015, the FOMC raised rates at its December
meeting, bringing the target range for the Federal Funds rate to 2.25% - 2.50%. While this move
was largely anticipated, recent market volatility and concerns about the economic outlook led
many investors to expect the Fed to pause rate hikes in 2019, even as the Fed itself maintained
a tightening bias. This mismatch in expectations between the market and the Fed regarding the
path of rates increases the possibility for a policy misstep, adding to the numerous downside
risks facing the economy. The Fed did adjust its growth outlook downward, coinciding with
softer manufacturing and housing market data, which further contributed to a substantial drop
in consumer optimism just months after the gauge hit an 18-year high. Notably, housing is a
leading indicator, and current data points suggest a tightening environment going forward as
home sales have been sluggish against a backdrop of challenged affordability and early 2018’s
rising mortgage rates. Meanwhile, in other forward-looking metrics, the Treasury yield curve has
flattened considerably as inflation expectations collapsed, and actually inverted between 2- and
5-Year maturities in mid-December. Whether the front-end inversion was a classic recession
signal or just a short-term kink that can be explained away by technical factors, it sent a warning
flag to investors as the impact of tax cuts and deregulation fade. The high-level view suggests a
decade-old economic recovery that is losing steam, while growth prospects are burdened with an
enormous debt build-up that will be increasingly more difficult to service prospectively...
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