Stocks Have A Positive Tone As Fed Shift Points To Lower-For-Longer Interest Rates
- Ulta Beauty ULTA , Workday WDAY report earnings that beat expectations
- PCE price index comes in lower than forecast
- Abbott gets emergency government authorization for cheap, rapid COVID test
As investors and traders continued to digest the Fed’s policy shift on inflation and employment, Wall Street had a positive tone this morning.
After briefly erasing its 2020 losses yesterday, the Dow Jones Industrial Average ($DJI) was looking like it would be in positive annual territory this morning, marking a major comeback from the coronavirus-induced selloff earlier in the year. The S&P 500 Index (SPX) was looking like it could post its biggest weekly gain in two months.
The rebound in equities has been due in no small part to actions from the Federal Reserve, which on Thursday gave the market another shot in the arm by announcing a policy shift that effectively means interest rates will stay near zero for a long time.
In commodities, oil prices were steady as Hurricane Laura didn’t cause widespread damage to refineries, and gold was higher in a bounce back from the previous session, supported by a weaker dollar and expectation of lower interest rates for a longer period of time.
In earnings news, Workday (WDAY) shares were up more than 10% after beating analyst expectations on earnings and revenue and hiking its revenue forecast. Ulta Beauty (ULTA) beat on earnings but slightly missed on revenue. While Ulta benefited from store reopenings and the e-commerce boom we’ve seen amid the pandemic, Workday’s cloud-based business software was in demand amid the accelerated shift to remote working.
In other news, New Zealand’s stock exchange has been under cyber attack this week. Hopefully, the issue will be resolved soon.
Domestically, the personal consumption expenditures price index for July came in below expectations, printing a 0.3% rise for both the headline and core readings. A Briefing.com consensus had expected a rise in the headline index of 0.4% and a gain in the core index of 0.5%.
The new inflation figures come a day after the Federal Reserve announced a major shift in how it targets inflation. Fed Chairman Jerome Powell on Thursday said the central bank is adopting a new policy of targeting an average yearly inflation figure. It will allow inflation to run higher than its 2% goal to make up for times when it is lower than that figure.
Powell also suggested that the Fed wouldn’t necessarily have to tighten monetary policy even if employment started running above estimates of its maximum level. That fed into market thinking that interest rates will remain lower for longer. (See more in-depth analysis on Powell’s speech below.)
Financials Fare Well
On the face of it, you might not expect a gain of 1.79% – the best of the SPX sectors – in Financials on a day when the Fed announced an employment policy that could keep interest rates lower for longer than previously expected. After all, banks make money when the interest they earn on long-term loans exceeds what they pay out in short-term rates on deposits.
But instead of the longer-term rate implications of a looser central bank monetary policy in relation to the labor market, investors instead appeared to be focusing on the potential for higher inflation from the Fed’s new targeting policy. With inflation in focus, the yield curve steepened on Thursday, a good sign for banks. Plus, a continuation of the stock market recovery could bode well for the megabanks that offer trading, mergers-and-acquisitions, and related services. JPMorgan Chase JPM (JPM), Wells Fargo (WFC WFC ) and Goldman Sachs GS (GS) are among those who had a nice day yesterday.
A COVID Test and Economic Data
Outside of the Financials sector, there was some good news on the coronavirus front, as Abbott Laboratories (ABT) shares on Thursday rose more than 7.8% after the company said it had gotten emergency government authorization for an inexpensive COVID-19 test that can return results in 15 minutes.
It’s not a cure, but the news seemed to contribute some positive energy to the market on Thursday. According to the ABT press release, the test comes with a mobile app that can allow people who test negative for the virus to show proof—something many see as a key to allowing large gatherings such as concerts, sporting events, and the thousands of bars and nightclubs that have been shuttered for months.
While the world is still waiting on a coronavirus vaccine or treatment, the potential for more testing is a step in the right direction toward bringing the pandemic under control.
The pandemic has taken a huge toll on the global economy, as well as that of the United States. In economic data Thursday, the government’s second estimate of Q2 GDP came in slightly better than expected. The government revised the figure to a decline of 31.7% from an initial estimate of 32.9%. A Briefing.com consensus had expected there to be no change from the first to the second estimate.
While it’s nice to see a smaller-than-expected decline, a fall of more than 30% for GDP is still a terrible figure and shows how far the economy has to go to recover, as does Thursday data showing initial unemployment claims above 1 million.
Tweaking Targeting: Inflation. The I-word. The economic scourge of the 1970s. Many people probably think about rising inflation as a bad thing. After all, it means every dollar you have is worth less than it used to be. But too little inflation can also be problematic. On Thursday, Powell said that inflation under its 2% objective is a cause for concern and that the central bank would allow inflation to rise above that mark to counteract periods of time when it is lower. Although he said policy makers are mindful that higher prices for essential items add to household financial burdens, he said too-low inflation can pose serious economic risks. In a cycle of lower inflation and inflation expectations, interest rates would also fall, and the central bank “would have less scope to cut interest rates to boost employment during an economic downturn, further diminishing our capacity to stabilize the economy through cutting interest rates.”
Encouraging Employment: Another major point of Powell’s speech yesterday centered on the idea of full employment. He noted that in the past, inflation tended to rise in response to a stronger labor market and that the Fed would sometimes tighten monetary policy as employment rose to “stave off an unwelcome rise in inflation.” As the labor market gets tighter, employers often have to pay higher wages to attract workers, and that extra cost can filter through into higher prices for goods and services. So it’s interesting to note that the Fed is now thinking that “employment can run at or above real-time estimates of its maximum level without causing concern, unless accompanied by signs of unwanted increases in inflation or the emergence of other risks that could impede the attainment of our goals.”
Getting Out of A Corner: With continuing unemployment claims above 14.5 million according to the most recent data, the economy is currently quite far away from full employment. Interest rates are also very low. Without the wiggle room on rates that it once had, the Fed it’s having to turn to other methods to help out the economy, such as encouraging lending to small and mid-sized businesses and, now, letting inflation rise above 2%. But getting inflation to move higher seems like it may prove difficult, at least for a while, given that the pandemic’s effect on the economy is, on balance, deflationary. We’ll have to see whether the policy shift at the Fed ends up boosting employment as hoped.
TD Ameritrade® commentary for educational purposes only. Member SIPC.