By projecting rates at current levels until 2023, which it did today, the Fed is going out a bit on a limb.
We all know how quickly markets can change, as witnessed early this year. So it remains to be seen if the Fed can come through on that promise. For now, it’s probably somewhat positive news for stocks because it’s even more clear that the Fed plans to remain accommodative for years to come.
The “dot-plot” showing individual Fed officials’ predictions for the rate path going out several years looks like most of them agree on flat rates for the next three years. However, the Fed’s decision today wasn’t unanimous. Two Federal Open Market Committee (FOMC) members dissented.
Also, the Fed today made clear that inflation above 2% “for some time” is its goal, which kind of quantifies some of the stuff Fed Chairman Jerome Powell talked about in his speech at “Virtual Jackson Hole” last month. Basically, the Fed sounds prepared to live with higher prices if a better economy pushes unemployment down. Stable prices and full employment are the Fed’s mandates, but it’s focused now on one over the other after spending years with 2% as its inflation target.
“Policy will remain accommodative until the economy is very far along in its recovery,” Powell said in his press conference.
While 10-year Treasury yields basically stabilized near 0.67% after the Fed’s announcement, Financial stocks seemed to get a slight lift after the news. That could reflect hopes that inflation might rise, forcing the Fed to get hawkish sooner than it expects. Crude climbed 5% to above $40 a barrel after the Fed meeting, a sign, maybe, that the Fed’s dovish policy could continue pressuring the dollar. A weaker dollar often leads to higher crude prices. Gold also climbed a bit.
While the Fed didn’t do anything with rates—and that could be the headline for a long time to come when you think about their dovish stance—it did have some fresh takes on the current economy. It’s probably going to surprise no one that the Fed continues to see the pandemic weighing on economic growth. In its assessment of the economy, it removed the word “somewhat” in saying that economic activity and employment have picked up in recent months.
It also removed the word “heavily” in the sentence saying the pandemic will weigh on the economy. These two very subtle wording changes might hint that the Fed feels some of the worst might be over.
As you watch the market over the rest of the day and into tomorrow, remember that it tends to react in an initial way and then sometimes reverses as more investors read over the Fed’s statement and listen to Powell’s press conference. All the major indices got some new life immediately after the announcement, but, as we said, markets can change quickly.
At his press conference, Powell said household spending has recovered about three-quarters of its losses, and activity in the housing sector has returned to where it was in the beginning of the year. There’s signs of improvement in business investing. Overall, the economy has picked up faster than the Fed expected, he added. “But the path ahead remains highly uncertain.”
The Fed sees unemployment dropping to 7.6% by the end of this year, and below 5% by 2023. Those struggling with lost income are being hurt by high food prices, Powell said, but overall inflation remains low. The Fed sees 1.7% inflation next year and 2% inflation by 2023.
Keeping Politics At The Gate
This is the last Fed meeting before the election, less than seven weeks away. If there’s one thing the Fed probably didn’t want to be accused of, it’s having any influence on the vote. In 1992, President George H.W. Bush felt that Fed Chairman Alan Greenspan acted too slowly bringing rates down in a recession, delaying the economic comeback and hurting his chances in November. He did lose, but you could still debate how much the Fed was to blame.
At least Powell doesn’t have to worry this time about an adjustment in rates getting pegged as political, because the Fed already has its hands off the wheel and says it will continue that way for a long time. You could argue that the Fed is moving away from traditional monetary policy rules that were born out of experiences by central banks in the second half of the 20th century. The question might be, does this hurt the Fed’s relevancy?
Since we’re talking politics, it’s kind of ironic that for months Fed Chairman Jerome Powell has said in no uncertain terms he thinks the economy needs more fiscal stimulus, not just monetary.
Remarks from the White House hinted at a bigger fiscal package than maybe people had expected after all these weeks of impasse, and that seemed to help lift banks, airlines, restaurants, and resort companies ahead of the Fed’s announcement.
Still, this is all just talk for now, and anyone who expects quick action from Congress on something this big probably hasn’t been watching over the last four months. It could be interesting if something starts coming together.
What If There’s Inflation Creep?
Since the Fed now is looking to get inflation above 2%, it’s worth a reminder that consumer prices just had three months in a row of relatively strong readings. It’s probably not something to get the Fed too excited, considering economic growth cratered last quarter and year-over-year inflation is down near 1%. Still going into Powell’s press conference it might be on some peoples’ minds.
Maybe it’s jumping the gun a bit considering weak demand across the economy and low energy prices, but one question that arguably hasn’t been answered is how high the Fed might let inflation go to get what sort of unemployment reading. It said above 2%, but how far above?
For instance, if inflation climbed to 3% but unemployment fell to 6% from above 8% where it is now, would the Fed be OK with that? Clearly nobody likes the present situation with unemployment so high. Still, the Fed has a dual mandate, with stable prices being one prong. Probably a worry for down the road, and maybe a challenge we’d consider ourselves lucky to face if it happens.
CHART OF THE DAY: HIGH HURDLE. Inflation expectations are still below the Fed’s long-term objective of 2% as seen in the 5-year forward inflation expectation rate (T5YIFR), which measures expected inflation (on average) over the five-year period that begins five years from today. Data source: Federal Reserve’s FRED database. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results. FRED® is a registered trademark of the Federal Reserve Bank of St. Louis. The Federal Reserve Bank of St. Louis does not sponsor or endorse and is not affiliated with TD Ameritrade. For illustrative purposes only.
In the Aggregate: One thing the Fed keeps a close watch on is aggregate demand. And on that topic—if new data from the International Energy Agency (IEA) is a guide—it’s looking less rosy these days. The IEA cut its forecast amid a weak recovery and risks that remain “elevated and skewed to the downside.” Crude—which pierced the $40 level just before Labor Day and had been hovering in the upper $30s per barrel but today ticked back above $40—has a long row to hoe, and it’s uphill both ways, which from the Fed’s viewpoint would make any less-than-dovish policy moves highly unlikely.
Cleaning Out the Garage: The Fed’s hauled out nearly every tool it has and some tools people didn’t even think it had to fight this recession. Unfortunately, here are growing signs from economic data that it might not be enough.=
Wednesday’s retail sales for August disappointed, and monthly jobs growth has slowed since June. While data had been relatively strong in other areas, the August retail and jobs numbers reflect the point where fiscal stimulus died down, so the question is whether there’s more sluggish data in store. Thursday’s August housing starts and building permits data and Friday’s consumer sentiment reading could be worth watching to get a better handle on where consumers are with stimulus still kaput for now.
If consumers are slowing down, it might be time to check economists’ Q3 gross domestic product (GDP) estimates for any sign of a pullback. Today, the Atlanta Fed’s GDPNow site pegged Q3 growth at an amazing 31.7%, up from its prior estimate of 30.8%. Most analysts predict much lower growth—around 20%. Normally 20% quarterly growth would be unimaginable, but after a more than 30% drop in Q2, basically even 30% growth doesn’t get the economy back to where it was. It’s still more than a month until investors get their first look at the government’s initial Q3 GDP estimate.
Bundle Up: On another energy-related note that might have ramifications for utility and transport stocks, prices for pressure tank rail cars to carry liquified petroleum gas (LPG)—a mixture of gases used in heating appliances, cooking equipment, and vehicles—are down going into winter, reflecting uncertainty over the coming winter season. That’s according to trade publication LP Gas, citing data from Energy Transport Insider. Refinery demand is seen as being weaker than usual, and propane demand is uncertain. The S&P 500 Utilities sector is down about 1% over the last month vs. a slight gain for the S&P 500 Index (SPX). Railroad stocks, however, have been chugging right along even amid the energy demand concerns. Both Union Pacific Corporation (NYSE: UNP) and CSX Corporation (NASDAQ: CSX) are among the railroads having a strong year, but the question is whether soft energy demand might start to weigh a little for those companies if their customers don’t need to ship as much LPG.
TD Ameritrade® commentary for educational purposes only. Member SIPC.
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