AAPL Apple Inc

By Michael S. Derby 

Federal Reserve expectations that it will be able to deliver two rate rises this year are being battered by mounting economic and market news that signals trouble for the economy.

The Fed already was expecting the economy to slow this year after a hot 2018, and the rate rises it projects for 2019 are under the four made in 2018. But it now looks that even two rate increases may be difficult to pull off.

Financial markets, by way of prices for federal-funds futures, have moved to cancel out any expectation of a rate rise. What's more, some investors and traders now see the central bank moving rates lower this year.

The shift in sentiment is driven both by volatile markets and the economic outlook.

On Wednesday, Apple Inc. surprised already rattled investors by warning of lower revenue tied mostly to weakness in China. Apple's troubles suggest the slowing in global growth Fed officials already were expecting may create even greater headwinds to the economy. The problem may get worse: President Trump economic adviser Kevin Hassett said in a Wall Street Journal interview that "multinational firms with profits in China are probably going to see at least that part of their profit picture sour a little bit."

Another bit of worrisome news came Thursday from the Institute for Supply Management's December manufacturing index. While it still shows expanding activity, the index marked its biggest one-month decline in a decade. Capital Economics told clients that the deceleration is "the first genuine economic reason for the Fed to potentially stop interest rates."

A bond-market indicator also is sending a bad signal. The difference between the three-month Treasury bill and the 10-year note has narrowed considerably. With the former at 2.41% and the latter at 2.58% midday Thursday, an inversion in the yield curve is a real possibility.

Inversions have often preceded recessions, even as economists still debate whether they correlate with downturns, or cause them. A recent San Francisco Fed paper said a sustained three-month to 10-year inversion is the most reliable market indicator of recession.

The Fed has been trying to signal that its monetary policy plans are far from set in stone. In late December, after the central bank raised rates, New York Fed leader John Williams went on CNBC to explain the central bank outlook.

"We are not sitting there thinking we know for sure what's going to happen," Mr. Williams said. For 2019, "something like two rate increases would make sense in the context of a really strong economy moving forward. But we are data dependent and will adjust our views" depending on what happens.

On Thursday, Dallas Fed leader Robert Kaplan, took a stand against rate rises. While he still expects the economy to grow this year, he told Bloomberg Television "we shouldn't be taking any further action until some of these uncertainties resolve themselves, and I think that could take several months."

Mr. Kaplan also said he is open to the idea the Fed at some point may need to moderate its continuing effort to shrink the size of its balance sheet. The reduction in holdings of Treasury and mortgage bonds has drawn criticism from some in markets that the process is tightening financial conditions too much.

So far, the Fed hasn't been buying that line. Fed Chairman Jerome Powell told reporters after the December Federal Open Market Committee meeting "the runoff in the balance sheet has been smooth and has served its purpose. And I don't see us changing that." Mr. Kaplan, who as a former top Goldman Sachs executive brings a special sensitivity to financial developments, suggests the possibility of change on that front has risen since December.

Mr. Powell has several opportunities to weigh in over coming days. He is set to speak at 10:15 a.m. EST Friday in Atlanta with former Fed leaders Janet Yellen and Ben Bernanke. He is then slated to speak Jan. 10 at the Economic Club of Washington.

"The challenge for the Fed is determining whether the markets are sending credible signals of a pending economic slowdown," Oxford Economics told clients. "We look for Powell to soften his tone and indicate as Williams did that the Fed will be flexible in adjusting their economic and rate outlook in the face of changing economic and financial conditions without pledging to pause for a defined period of time."

Write to Michael S. Derby at michael.derby@wsj.com

(END) Dow Jones Newswires

January 03, 2019 15:16 ET (20:16 GMT)

Copyright (c) 2019 Dow Jones & Company, Inc.