David Zervos: The Fed is ‘the greatest monetary policy experiment in history’

For those of you looking to settle the debate about what matters most to markets — fed policy or trade policy — one prominent Wall Street veteran says look no more, it’s not even a contest.

“It’s so depressing to watch the world of mainstream economic punditry to try to blame its epic 2019 forecasting failures on trade policy changes,” said Jefferies Chief Market Strategist David Zervos in a note to clients. “Just to be clear, so far $200 billion of goods from China, representing about 1% of U.S. GDP, are subject to a 25% tariff. And that’s supposed to topple the $20 trillion U.S. economy?? Pullleaasee.”

Instead, Zervos says, it’s Fed policy that truly matters to the market and the economy.

“The real story of why we get a slowdown this year -- why things are a little rickety and why we feel some jitters — come from rate hike cycles,” Zervos said in an interview on Yahoo Finance The Final Round. “What we've seen is particularly post crisis, monetary policy has just become a much more important driver of financial markets and even economic activity.”

All eyes on the Fed

Investors are particularly focused on the Fed this week as it kicks off its 2-day policy meeting.

And while some hopefuls on Wall Street are looking for a rate cut, Zervos says a June easing is premature and that we’ll likely see some dovish guidance from the Fed.

“With S&P (^GSPC) just ~2% off record highs and the unemployment rate at 3.6%, I suspect the majority [of the Fed members] will fall in-line with some very dovish ‘insurance guidance’ and they will refrain for now from ‘insurance cuts,’ writes Zervos.

The Fed kicks off its two-day monetary policy meeting on Tuesday, with the committee due to release its statement and decision on rates at 2 p.m. EDT on Wednesday. Fed Chair Jerome Powell will hold a press conference immediately following the statement’s release.

As of now, traders are pricing in a 26% chance of a cut at the Wednesday announcement. But looking further out, market expectations of looser monetary policy jump to 89% in July and nearly 97% in September.

CME Group chances of a rate cut
CME Group chances of a rate cut

Market reaction to Fed’s statement

While the first two trading days of the week have been muted on Wall Street, Wednesday will likely see a surge in trading activity once the Fed sheds some light on its course of policy action.

According to Zervos, that does not necessarily mean a selloff. Even if we don’t see a June rate cut, Zervos says that a strong message from the Fed clearing the way for an easier near-term policy could easily offset any disappointment from delaying the cut.

“The front end of the bond market might be a tad disappointed with this outcome, but if the messaging is executed properly, the long-end and risk assets should not be too bothered by the decision,” says Zervos. “I think that they're going to set us up for something, a very low bar to set a move at some point later this year -- whether it's the end of July, whether it's sometime in the fall.”

Fed’s growing influence

And while we may not see an immediate and sizable move in markets, in the long term Zervos says the Fed’s influence has grown and monetary policy has become a much more important driver of markets and economic activity.

“We give the Fed more and more power after every economic downturn,” Zervos told the Final Round. “I mean, this is the greatest monetary policy experiment in history, right? Taking the balance sheet from $800 billion to $4.6 trillion. This is unbelievable what we've done. And the power that comes with that in the future is something that investors cannot ignore and say monetary policy doesn't matter. It matters. It matters a lot.”

Follow Yahoo Finance on Twitter, Facebook, Instagram, Flipboard, SmartNews, LinkedIn,YouTube, and reddit.

Advertisement