After Fed Keeps Rates Unchanged, Market Moves Mostly Higher, But Techs See-Saw
A year after initiating zero interest rates in response to Covid, the Fed’s long-term outlook still doesn’t show it “thinking about thinking about” getting less accommodative with its policy before 2023. Despite mounting 10-year yields and a rapidly improving economy, the median Fed policy outlook doesn’t anticipate any rate hikes until 2023 at the earliest, the same as in December, the Fed said Wednesday following the Federal Open Market Committee (FOMC) meeting. As expected, the Fed left rates at approximately zero for now. Stocks had been down modestly to moderately before the Fed came out with its projections, then rallied pretty well right after the news hit. Within 20 minutes or so, most indices were flat to higher, though the Nasdaq (COMP) remained under some pressure. It’s not unusual to see the indices bounce around quite a bit in the hour following a Fed announcement, so it remains to be seen how it all shakes out by the close. The closely watched 10-year Treasury yield, which had ticked up to a new 13-month high of nearly 1.69% earlier today, remained higher but off the peak levels at around 1.66% soon after the Fed announcement. Fed Sees Inflation Moving Up Going into the meeting, some analysts had expected the Fed’s dot-plot might look a bit more hawkish. While a few more Fed officials do anticipate a rate hike next year vs. the number who did in December, it wasn’t enough to move the median needle. What’s interesting is that the Fed now sees core inflation hitting or exceeding its 2% target this year and next, but doesn’t expect to raise rates despite that. Maybe that shouldn’t surprise anyone, considering Fed Chairman Jerome Powell has been saying for a while that he’d be comfortable with inflation above 2%, and is more focused on employment recovering fully from the pandemic. “We could see upward pressure on prices,” Powell said in a press conference following the meeting, but he thinks that would only have a “transient impact” on inflation. Additionally, the Fed sees no changes in its $ 120 billion a month bond-buying program, which is designed to push down borrowing costs and keep liquidity flowing in the economy. More Fed Officials Warm To Idea Of 2022 Hike All this doesn’t mean nothing’s changed. First, four Fed officials now see a chance for at least one interest rate hike next year, up from just one who did in December. And seven see chances of a hike in 2023, up from five in December. Also, the Fed sounded more optimistic about the economy overall, changing its statement from the previous meeting to note that “indicators of economic activity and employment “have turned up recently.” It sees no signs of serious inflation at the moment, and expects 2021 gross domestic product to climb an impressive 6.5%, which would be the best annual performance in about 35 years and up from its 4.2% projection in December. It also raised its 2023 GDP projection slightly to 3.3%, from the previous 3.2%. The Fed now sees unemployment falling to 4.5% this year, and 3.7% in 2023, vs. the December estimates of 5% and 4.2%. Inflation this year will rise to 2.4% before moderating back to 2% next year, the Fed said. That’s a lot of data to work through. Putting them all together, though, you get what looks like a very rosy picture shaping up for the economy: Robust economic growth, falling unemployment and not enough inflation to get people too worried. Assuming the Fed is right, of course. Even Fed officials would admit they don’t have a crystal ball, and neither do investors. The Fed actually sounds a bit more cautious than the average investor when it comes to Covid, saying the virus will determine the future path of the economy. A lot of people in the market have already started to look at reopening as a fact on the ground, whether that’s justified or not. The virus remains a wildcard, as far as the Fed is concerned. Powell Notes: Accommodative Stance, No Plans To Taper Or Jump the Gun “The economy is a long way from our employment and inflation goals,” Powell said in his press conference, vowing to remain accommodative. He added there’d be no “tapering” of the Fed’s bond-buying until the Fed sees “further substantial progress” in the economy meeting its goals, and reiterated that the Fed would give the market plenty of warning ahead of any plans to begin tapering. He also said the Fed is operating a little differently than in the past, something investors need to get used to. The “fundamental change” in the Fed’s framework, he said, is “we’re not going to act preemptively based on forecasts, for the most part. We’re going to wait for actual financial data. It will take time for people to adjust to that, and the only way we can build credibility around that is by doing it.” In other words, the Fed has said it will let inflation run above 2% before raising rates, but inflation hasn’t gotten there yet. It’s now telling investors that once inflation does hit 2%, the Fed will keep its hands off the tiller. That’s a very different strategy than we as investors might be used to, but it’s something to keep in mind going forward. Powell didn’t respond directly to a question from the media about his thoughts on the rising 10-year yield, only saying the Fed believes its stance is appropriate. A “disorderly” move in the market would concern him, however. There’s no sign of the Fed planning a “twist” in its bond-buying program toward buying longer-term debt. CHART OF THE DAY: BONDS AND BARRELS. How have Treasury rates, the “reopening trade” and to some degree the inflation outlook fared? This six-month chart showing the Cboe 10-Year Treasury Index (TNX—candlestick) and NYMEX Crude Oil futures (/CL—purple line) seems to say it all. They’ve been tracking almost tick-for-tick since last fall, and mostly higher. Data sources: Cboe Global Markets, CME Group. Chart source: The thinkorswim® platform. For illustrative purposes only. Past performance does not guarantee future results. Lessons From a Year Ago: If you were reading this column a year ago today, you probably felt your head spinning after most major indices collapsed 12% amid Covid uncertainty the day before. While not everything in that column turned out to be prescient (no one is clairvoyant), there were nuggets that some readers hopefully took to heart. First, the column noted that the S&P 500 Index’s (SPX) 12-month forward price-to-earnings ratio had descended to just below 14, which also happened to mark the forward P/E bottom of the late-2018 market pullback and was below the historic average P/E of 15.5. While we didn’t make predictions, astute readers might have noticed that when the market does hit long-term lows in P/E, that’s often a sign of a bottom possibly forming. In last year’s case, there was still a week of pain to come as the SPX hit its low on March 23, but the P/E didn’t decline much further and eventually climbed above 22. As we noted at the time, “It’s possible we could look back six months from now and say stocks got ‘oversold’ if things come back more quickly than the worst-case scenario that’s being priced in.” Lessons, Part 2: Housing. The column a year ago also noted that housing might be a shelter for people in a pandemic economy. “The housing market could be resilient even if consumer spending takes a hit, (as) interest rates are once more ultra low.” Pretty elementary, perhaps, from an economic standpoint. Psychologically, however, it was a warning not to panic. Even when it feels like everything is going straight down, there are aspects of the market investors can look at for support. As it turned out, housing ended up being a segment that did very well through the second half of 2020 and helped lead the country out of recession. But if interest rates do continue their march forward—particularly at the long end—rising mortgage rates could certainly dent the housing rally. Birds of a Feather? So far this year, both the 10-year Treasury yield and crude oil have gone up pretty much without a break. To date, the yield is winning the foot race by a mile, up 83% since Dec. 30 vs. 39% for crude. Still, both are steep climbs in a very short period of time, and are definitely raising eyebrows in the camp of those who worry about inflation. Economists argue about how closely linked yields and crude are historically, with some saying not much. However, higher yields, if followed by higher interest rates, might lift the dollar, which tends to put pressure on crude. If the Fed decided to get more hawkish, the question becomes where do these two key metrics go? Though the idea of the Fed putting a tighter regime in place might be a threat to the crude rally, economists forecast very strong U.S. growth, which might outweigh anything the Fed does as far as the price of oil is concerned. Also, some might argue that the 10-year yield has already done a pretty good job of building in more hawkish Fed policy, so it might not need to go much higher, at least for now. TD Ameritrade® commentary for educational purposes only. Member SIPC. 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