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The Fed's recent behavior shows it's very nervous about the economy's future. Here are 3 reasons why you should be too.

Business Insider | Jun 5, 2019, 08.46PM IST

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Carlos Barria/Reuters

  • New rhetoric from the Federal Reserve shows the central bank is softening its stance on monetary policy in response to recent economic and market turmoil.
  • Investors are feeling the heat in the face of the Fed's acknowledgement of potential policy adjustments.
  • We provide three reasons why, given recent commentary from the Fed, investors should tread lightly in the current environment.

The Federal Reserve is starting to sweat. And the central bank's rising level of concern is a direct result of mounting pressures being felt throughout the market.

Investors have been tip-toeing through a minefield of an economic landscape as of late. In recent weeks, they've been simultaneously contending with escalating trade-war tensions, an inverted yield curve, and the looming spectre of slowing global growth.

"The narrative on global trade has darkened," James Bullard, the president of the St. Louis Fed, said on Monday. His comments wound up exacerbating uncertainty in an already-jittery market, sending stocks diving.

But the Fed has heard the cries of investors, and is no longer failing to acknowledge their desperate pleas for clarity.

This was apparent on Tuesday, when Fed Chair Jerome Powell soothed market nerves by hinting that the central bank will take all necessary measures to keep the economy - and, by extension, markets - afloat.

"We are closely monitoring the implications of these developments for the US economic outlook," Powell said. "And, as always, we will act as appropriate to sustain the expansion, with a strong labor market and inflation near our symmetric 2% objective."

This note was perceived by many as a capitulation by the Fed Chair, acknowledging the lack of sentiment and confidence present in the US' ability to navigate through a plethora of strained trade relationships.

Investors breathed a sigh of relief, culminating in a 500-plus point rally in the Dow Jones industrial average. However, the respite may be short. If Fed officers are so susceptible to changes in sentiment, what's the say they won't abruptly shift gears again at some point?

The big takeaway of it all is that the Fed looks willing to do whatever it takes to achieve stability. But the underlying truth is that widespread worries have made them that way. And if the Fed is concerned, investors should be as well.

With that in mind, here are the three main reasons why investors should tread lightly in the current environment:

(1) Confidence in the US' ability to ride out the trade war is waning

China is taking a page out of Tom Petty's book and not backing down against the US when it comes to trade. The confrontation, once perceived as "easy to win," is turning out to be much more difficult than originally anticipated.

If tensions continue to escalate, bottom lines will feel the effects of rising input prices, dwindling demand, and fledgling investor sentiment. In short, investors may ditch their holdings if the light at the end of the tunnel is not readily within view.

(2) The Fed has less room for error

The Fed uses monetary policy to ameliorate economic weakness in unfavorable times, so it's safe to say that if cuts are coming the US economic landscape is in less than ideal shape. Today, the Fed funds rate is hovering near historic lows, effectively leaving policymakers with less room to combat unfavorable conditions. In short, the Fed is playing tennis with half a racket.

(3) The Fed makes mistakes

The Fed simply cannot foresee developments in the global and political landscape, making their future bets on policy inherently fallible. Every adjustment made is based on probabilities and best guesses.

Sometimes, these guesses turn out to be the wrong move at the wrong time, as unforeseen events and circumstances undermine a strategy with the intent of hitting a moving target. It may take markets longer to recover if the Fed can't things under control.

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