“No Surprises” Department: Fed Leaves Rates Alone, Keeps “Free Money” Policy In Place
- Fed surprises few if any by leaving rates unchanged again, still near zero
- New statement notes that economy remains weaker than it was pre-pandemic
- Fed cites “continued recovery” in economic activity and employment
It’s over. The outcome everyone’s been waiting for today hit the headlines and we can breathe a collective sigh of relief.
The Fed left rates unchanged, and the decision was unanimous.
That was the outcome you’ve been pacing the floor about, right? Fat chance. The Fed’s pledge to keep rates at levels near zero for years has really thrown a wet blanket on the drama these meetings used to generate. And this Fed gathering didn’t even include any long-term rate projections, something we’ll get next month.
Still, the decision seemed to inject a bit more energy into a market that was already sharply higher heading in based on bullish expectations about a “house divided” situation in Washington that could mean less fear of tax or regulatory changes. And while the Fed meeting is likely overshadowed by all the election drama, it still delivered what bullish traders’ arguably want: A hands-off approach to monetary policy.
Industrials, Financials, and Materials were among the sector leaders this afternoon while the bond market barely moved right after the Fed decision. The S&P 500 Index (SPX) recently was more than 2% higher, and is nearing recent peaks.
This continued Fed commitment to a “free money” policy almost definitely supports equities, and “no news is good news” as far as the Fed not changing its tone. However, sometimes Fed Chairman Jerome Powell contributes a bit more market drama with remarks at his post-meeting press conference, so we’ll see if there’s any reaction to what he says.
In his press conference, Powell said the housing sector has “fully recovered” but the services industry—including hospitality and travel—suffer from low spending. Overall, he said, “the pace of improvement has moderated” since the big bounce that came in May and June, referring to things like payroll growth. In a sense, this is expected, he said.
But risk of further spread of COVID-19 and households running through their savings could weigh on activity. He sees continued growth and expansion, but at a gradually moderating pace. He added that the Fed’s asset purchases have supported the economy, but said the Fed is maintaining the current level of those purchases, now at $120 billion a month.
He added that the Fed’s asset purchases have supported the economy, but didn’t say anything about raising the level of those purchases, now at $120 billion a month.
He remains determined to “put these emergency tools back in the toolbox” once the crisis ends.
Aside from the press conference, the only real drama from recent Fed meetings is figuring out what Powell and company have up their sleeves to try and stimulate growth in this COVID-19 era. The other thing is to parse the Fed’s statement for any changes in how Fed officials see the economy coming along, including metrics like inflation and growth.
Today’s Fed statement barely changed from last time, only noting that the economy and employment “continued to recover,” but remain well below their pre-pandemic levels. That’s something investors learned late last month from the Q3 gross domestic product (GDP) estimate, so nothing really new. The new statement did delete the words “picked up in recent months” from the description of economic activity and employment, which could imply things are simply continuing to grow at a steady pace.
“The COVID-19 pandemic is causing tremendous human and economic hardship across the United States and around the world,” the Fed said.
The Fed’s target rate has been between zero and 0.25% since March when the central bank quickly responded to the first wave of the pandemic. Analysts don’t foresee any change for a while to come. Research firm CFRA, for instance, said in a note this week that it expects a “sustained zero interest rate policy position for the foreseeable future given the shift to average inflation targeting that would imply zero rates beyond the return of inflation to 2%.”
That was a reference to the Fed recently saying it would be comfortable keeping rates flat even with inflation rising above its 2% target level if it helps bring the economy back toward full employment.
Worried About Inflation?
Speaking of inflation, is it something investors need to worry about? The Fed has basically adopted a “what, me worry?” attitude toward inflation recently after years of trying and failing to get it to 2%.
There’s little sign of inflation popping back, despite recent strong data and this week’s rally in the stock market. While the Treasury market arguably hinted at a little inflation worry earlier this week when the 10-year yield hit a nearly five-month high of 0.9%, it’s now back to 0.77% amid the election uncertainty. That’s not far above recent troughs below 0.7% and still a historically low level basically never seen until now. If investors had inflation worries front and center, there’s probably no way yields would be so deep in the mud however long the Fed promised to keep its hand off the rate hike handle.
The latest word on inflation going into Thursday, according to the Personal Consumption Expenditures (PCE) price index that the Fed has said it relies on for the best picture of prices, suggests there’s not much there. PCE core inflation (which strips out food and energy) rose 1.5% year over year in September, the government said last week. Both PCE and core PCE rose 0.2% month over month. Those aren’t what you’d call alarming numbers, and they definitely don’t get you anywhere near where the Fed wants to be up at 2% and above.
This implies that both the Fed and Congress have room to work without triggering any runaway price fears, at least for now. Things could definitely change, for instance, if a vaccine comes out and life gets back to normal at some point next year.
The Fed’s decision today followed a decision earlier Thursday by the Bank of England to keep its main lending rate at 0.1% and step up its bond purchases.
Where Things Stood Heading into Fed Decision
The market’s been on a tear since election day partly because investors seem to like the idea of a gridlocked capitol. Heading into the Fed’s decision, the S&P 500 Index (SPX) was up more than 2% Thursday. Bonds were also up, however, which means some relationships continue to be off. The 10-year yield traded at 0.77% minutes before the Fed statement came out, down 13 basis points from recent peaks.
It does appear possible investors (and the rest of the country) could get some additional clarity on the election results today. Volatility continued to edge lower Thursday with the Cboe Volatility Index (VIX) under 28 prior to the Fed announcement. It is possible, however, that VIX could go back up once the election returns become final.
Every sector rose Thursday before the Fed statement, but leaders included Materials, Industrials, and Info Tech.
Grading the Curve: Heading into the election, strength in longer-term yield had really helped widen the closely watched “yield curve” between 10-year and two-year Treasuries. It stood at around 70 basis points immediately prior to Nov. 3, but then slipped to near 63 as investors piled into Treasuries on Wednesday and Thursday amid election-related uncertainty.
This curve was a lot tighter at one point. Eight months ago, for instance, only 15 basis points separated the two. As the curve widens, it tends to help Financial stocks, which often achieve better profit margins when the curve starts favoring longer-term yields. At the same time, however, those increasing yields on the long end of the spectrum seem to be weighing a bit on the housing sector, even though 30-year mortgage rates remain barely above 3%. As for Financials, they’ve been building strength recently despite the yield drop this week, trail the S&P 500 Index (SPX) over the last three months. They’re up 2% over that time frame vs. 4% for the SPX.
Where Do Yields Go from Here? You could argue that the little dip in yields as votes got counted Wednesday and Thursday doesn’t mean all that much. It’s more of a muscle memory thing where uncertain times generate a flight into fixed income, as we often see. The next week or two—assuming the election gets decided—could be interesting for the bond market to see if that pre-election pattern resumes. Whoever wins has promised to push for a quick economic stimulus, and just after the election Senate Majority Leader Mitch McConnell said he might favor stimulus before the new year.
The intensity of this new virus wave also could steer Congress toward a quicker move, and the Fed last week made it easier for small businesses to borrow money—which could also help get things moving. Data is key, too, as we await tomorrow’s October payrolls report. If that report and other numbers continue looking strong, that’s possibly even more weight on the bond market and a springboard for the 10-year yield on its way back to recent highs near 0.9%. On the other hand, the recent huge rally in stocks might bring profit taking, and some of those profits could get steered into fixed income. There are a lot of moving parts right now.
Thanks, Fed! Even with election and stimulus uncertainty still in the mix, it seems like there’s a certain amount of stability in the market because of expectations the Fed will do whatever it can to help out the economy. This tends to put a floor under major indices in what’s often called the “Fed put,” meaning investors often buy on dips thinking the Fed will come to sweep up if things get messy. We’ve seen that pretty much the last six months, with the SPX mostly staying above key support at its 200-day moving average over that time period.
The 200-day moving average, obviously, has been moving up along with the SPX and currently rests near 3130. Some analysts say a closer range of technical support is in the 3200 area.
TD Ameritrade® commentary for educational purposes only. Member SIPC.