Mixed View: Fed Keeps Rates Unchanged As Powell Suggests Reasons For Hope, Warning Signs

No rate change, but you probably already expected that. 

What wasn’t as widely expected from today’s Fed meeting conclusion was a bit more of an optimistic tone in the Fed’s statement, which seems to be giving stocks a little boost here in the late going of Wednesday’s session. That said, Fed Chairman Jerome Powell also added a bunch of things to worry about, including some possible slowing in the economy as caseloads spike.

The Fed, as markets had factored in, held rates steady in a range near zero at its meeting Wednesday afternoon. It’s now more than four months since the Fed pushed down its benchmark rate to between zero and 0.25%. 

After the Fed’s decision, the S&P 500 Index (SPX) held onto earlier gains and started to build on them a bit, but the dollar continued to edge to new multi-year lows and Treasury yields didn’t really see any change for the better. The Fed’s trying its best to use dovish policy to inject some zip back into the economy, and its statement indicated it does see some reason for optimism.

What’s Changed? A Hint of Optimism

Key changes in the language include the Fed saying “Overall financial conditions have improved in recent months,” a bit of an edit  from the previous, “Financial conditions have improved.” 

It’s hard to read this as anything but the Fed indicating that things have improved across more of the economy and over a longer period, which could help explain why 10-year Treasury yields rose slightly after the decision before inching back into the red. They’re still incredibly low at 0.58%.

Also on a bullish note, the Fed added that employment, along with economic activity, has picked up in recent months. Last time it just said economic activity, with no reference to jobs. However, it added that both “remain well below their levels at the beginning of the year.”

“The path of the economy will depend significantly on the course of the virus,” the Fed’s statement said in new language added this meeting. 

Language that didn’t change from last time included the Fed promising to continue increasing its holdings of Treasury securities and mortgages. This should potentially continue to help the housing market. The Fed said it will also “use its tools and act as appropriate” to support the economy. None of that is new.

These Fed meetings are becoming more about what Powell has to say at the post-game press conference and less about what the Fed plans to do with rates. The central bank’s own predictions are for rates to stay at current low levels through the end of next year and into 2022. The question Powell might face is whether this can continue if inflation starts to show up due in part  to the weak dollar that low rates tend to contribute to.

It was kind of a weird day on Wall Street as the financial networks had to transition from their live coverage of a congressional hearing involving top executives from Alphabet Inc GOOGL GOOG, Amazon.com Inc AMZN, Apple Inc AAPL, and Facebook Inc FB over to Powell at the Fed (where he appeared to be showing up in person, not from a distance).

Powell Talk

Powell peppered his post-meeting remarks Wednesday with some good and some bad. The Fed’s seen some pickup in factory activity, and household spending has recovered about half of its earlier losses, though travel and leisure lags behind. Stimulus payments and unemployment benefits helped households, he said.

Also, about one-third of the lost jobs have been regained, he added.

As for inflation, the pandemic has had a mixed impact, Powell said. It’s raised food prices due to supply constraints, but prices for travel and leisure have fallen and inflation remains well below the Fed’s 2% objective.

Ominously, Powell said there are some signs that the recent rise in virus cases is having an impact on economic activity. Credit and debit card use looks like it’s down since late June.

Powell had a pretty passionate message for Congress as far as urging more fiscal stimulus. He credited the first round of money from Congress as successful, but said even if reopening goes well, industries that involve a lot of people getting together (like restaurants and bars) have a long path ahead, and many workers there won’t be able to get their jobs back.

“There will be a need...in the broad scheme of things, for more fiscal policy,” Powell said.

He added that consumer sentiment surveys appear to be softening after their initial reopening recovery as cases spike here in July, though some aspects of the economy like housing and motor vehicles sales look better. There seems to be some slowing in the recovery, but “it’s too early” to say how long or sustained this might be, as the Fed awaits data on spending and employment, Powell said. So investors should consider watching those same things in the weeks ahead.

He said there’s been a big shock to demand and that COVID-19 is “disinflationary” and that the economy will be struggling for a long time against disinflationary, not inflationary pressures.

Great Expectations? Not Necessarily

As the Fed prepared to gather, it might have been the least anticipated Fed meeting since...well, the last one.

Maybe even less anticipated than the last one, actually. At least that one promised some drama with the release of freshened long-term interest rate predictions in the quarterly “dot plots.” Those represent the Fed’s most up-to-date ideas about where the rate environment is headed, and showed Fed officials pretty much united in seeing no uptick from zero through 2021 and possibly 2022.

That wasn’t exactly welcome news for the Financial sector, where banks rely in part on net- interest margin for their lending profits. That sector keeps languishing, possibly a challenge for the broader market if Tech can’t regain its footing here following a short dip. Though it hasn’t been the case lately, old timers say it’s hard to have a long rally without the banks.

Last time out, in June, Powell made it absolutely clear that higher rates weren’t coming anytime soon. In fact, he memorably said the Fed “isn’t even thinking about thinking about” raising rates. It’s hard to get more definitive than that. 

He also delivered some unpleasant observations on the economy back then, saying, “Indicators of spending and production plummeted in April, and the decline in real GDP in the current quarter is likely to be the most severe on record.” Tomorrow morning brings the government’s first official look at Q2 GDP, and consensus on Wall Street is for a 35% slide, according to research firm Briefing.com. To say that’s off the charts is a major understatement.

The question is whether Powell sees any deflation on the horizon, or, on the contrary, if there’s a chance these record low rates could begin to stir inflation. At this point, a bit of inflation might be welcomed by some as a sign of economic vigor, though others would say higher prices are the last thing people need as they struggle to provide for their families.

So what does the Fed have left in the toolbox if things get worse? Well, it already did one thing this week, announcing Tuesday that it’s keeping seven of its emergency pandemic lending facilities open to applications for an additional three months (see more below).

CHART OF THE DAY: GOLD RUSH: Investors are likely turning to gold (/GC—candlestick) as a potential hedge especially with treasury yields as low as they are, which is reflected in the 10-year treasury index (TNX—purple line). Data sources: CME Group, Cboe Global Markets. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.  

Lonesome Website: Until this year, it was many analysts’ and investors’ habit to spend a minute or two everyday checking the CME’s FedWatch tool. The handy little site gave a quick look at the market’s expectations for a rate hike or a rate cut at the next few Fed meetings, based on the performance of CME Fed funds futures. Then you could come away knowing that chances of a hike were, say, 70% at the next meeting and 90% at the meeting after that. Or maybe the Fed would be more likely to cut. Either way, it was simple to get a good sense of where things stood. It was kind of like the famous “Doomsday Clock” in Washington that tracked scientists’ expectations of global catastrophe. 

These days, that old site-check habit has fallen by the wayside for many. Why check expectations when the Fed chair himself has said, “We’re not even thinking about thinking about” a rate hike? And going into Wednesday’s decision, the once go-to site listed expectations as 100% of absolutely no change to rates at this month’s meeting. Chances of no change in September, November, and December? 100%. Even by next March, things are expected to be the same as now. The Fed’s taken some of the drama out of life, and for now, one task off the day’s to-do list. 

Keeping the Glass Full: The Fed looks like it’s planning for the current economic troubles to last a bit longer. It announced Tuesday that it’s keeping seven of its emergency pandemic lending facilities open to applications for an additional three months. The Fed was previously planning on a Sept. 30 closing date for the seven facilities, meaning that companies or banks that want access to Fed liquidity would need to apply by that date. The extension means that they can now apply through Dec. 31. 

Basically, what we’re continuing to see is the Fed doing whatever it can to keep the liquidity situation reliable as long as it takes to get through the crisis. This move could get a bullish read if you look at it that way, or it might seem bearish that the Fed apparently expects troubles to continue well into the late part of 2020.

Corporate Troubles Become the Fed’s Problems: Lack of company certainty has possible implications beyond their individual balance sheets, and could spill into the Fed’s areas of responsibility.  For instance, company worries could be keeping employment from coming back as quickly as the Fed might have hoped, because companies that feel uncertain about the future probably won’t be too eager to fill new positions. In fact, many are trying to cut costs by eliminating positions, as we saw from some of the airlines. 

Last Thursday’s weekly initial unemployment claims climbed approximately 100,000 from a week earlier, the government said, and are now rising for the first time since March. Longer-term unemployment claims are staying stubbornly high. It goes without saying that the millions of people who can’t get jobs aren’t likely to be spending more, so the July economic data due out in coming weeks is probably also going to get a close look from the Fed for any signs of a lag from the initial spring recovery.

Also, if people don’t have jobs and demand falls, that tends to weigh on prices and might prevent the Fed from maintaining its goal of monetary stability. At this point, deflation doesn’t necessarily look like a pressing problem, judging from recent data.

TD Ameritrade® commentary for educational purposes only. Member SIPC.