Is Patience Still A Virtue? Maybe Not, As Fed Strikes That Word, Hints At Future Cuts

The Fed is out of patience, but plans to hold steady for now.

The market arguably got what it wanted from today’s Fed meeting conclusion: Hints at a future rate cut, while at the same time the Fed removed the word “patient” from its statement. 

Stocks rose on the news, but before throwing a party, investors might want to remind themselves that lowering rates—something the Fed seems to be hinting at—is a panacea as well as a signal that the economy is slowing. Long term, this is not a good sign. Also, it seems like a lot of the Fed’s more dovish signals had already been built into the market during the recent rally.

The Fed’s “dot plot,” or forward projection by various Fed officials, actually showed the Fed still at odds about whether to cut rates this year. Officials were almost evenly divided between making no cuts and making one or more cuts before 2020. The jury is still out, apparently, with nine Federal Open Market Committee (FOMC) members predicting no rate cuts this year and eight predicting one or two.

That’s not the way investors apparently see it, judging from how the futures market acted right after the meeting. Fed funds futures now show a 100% chance of at least a 25-basis point rate cut at the Fed’s July meeting. Futures also show 80% odds of rates being cut by 50 basis points between now and September.

Fed Outlook For 2019 Gets Weaker

Turning to the Fed’s economic outlook, the FOMC cut its forecast for Personal Consumption Expenditure (PCE) inflation this year to 1.5% from 1.8%. Its 2019 gross domestic product growth (GDP) estimate was unchanged at 2.1%. That’s down from 2.9% in 2018.

The FOMC’s dot plot predicts one rate cut next year that drops the fed funds to 2.1%, with one increase in 2021 bringing it back to the current 2.4% level, Marketwatch noted. In another move, the Fed lowered its “longer run” forecast for its fed funds rate to a new low of 2.5% from 2.8%.

In the first minutes after the Fed’s decision, stocks rose slightly to their highs for the session. It wasn’t much of a surge, though, and stocks often make bigger moves during and after Fed Chair Jerome Powell’s post-meeting press conferences. While the statement said the Fed “will closely monitor” the economy in light of growing “uncertainties,” Powell often gives a more detailed analysis. Sometimes his words have appeared to scare some investors, and other times they might have lifted spirits.

The Fed’s new statement wasn’t all that surprising, pulling back on some previous language about a thriving economy. Economic growth, the Fed said, is rising at a “moderate” rate, not a “solid” rate as it said last time out. Business investment, the Fed said, hasn’t just “slowed,” it’s been “soft.” 

In addition, the Fed had a new sentence saying “uncertainties” about its outlook for a strong labor market, expansion of economic activity, and 2% inflation have “increased,” and the statement reiterated language Powell used in a speech earlier this month, saying, the “Committee will closely monitor the implications of incoming information for the economic outlook and will act as appropriate to sustain the expansion.” It also cited “muted inflation pressures,” perhaps indicating there’s a clear runway if it does decide to lower rates.

One thing the Fed didn’t refer to in its statement was any new language about chances for a near-term rate cut. That’s something Powell is likely to be asked about at his press conference.

In his opening statement at the press conference, Powell said the outlook remains favorable, but that uncertainties have increased since the early May meeting. These uncertainties include the turbulent tariff situation between China and the U.S., slowing business investment, weaker overseas economies, and weakness in inflation. He talked about how these various “cross currents” have re-emerged more strongly in the last few weeks and need to be watched carefully, but also noted that the Fed can’t risk acting on any one data point and will have to see if the uncertainties continue to weigh on the outlook.

Some FOMC members, he said, are concerned about the inflation shortfall and believe a cut in the Fed Funds rate “would be appropriate” if the economy continues in the scenario they see it most likely going. Even some of the participants who predicted no rate change the rest of the year, he said, can see a scenario where rates might need to be lowered.

Stocks Surged as Meeting Approached, Despite Economic Signals

The U.S. stock market marched confidently into this particular Fed meeting, rising nearly 7% since its early June lows as many investors anticipated a more dovish central bank. What seemed to get ignored in the rally, for the most part, was the very factor driving hopes for rate easing: A mild global economic slowdown.

Easier monetary policy doesn’t usually happen when everything’s going great, so it’s really a “bad news might be good news” type of scenario that many investors seem to be contemplating. Overseas economies have been sluggish for months, with the latest Chinese data last week another sign of possible softness there. Earlier this week, European Central Bank President Mario Draghi hinted at a possible new stimulus as the benchmark German bond yield fell to a record low of minus 0.329%.

While a Tuesday tweet from President Trump saying he’d meet next week with Chinese President Xi seemed to unleash a little trade-related optimism, it was arguably the first time in more than a month that we’d heard any positive trade news. Even with hopes for progress at that meeting, the potential for increased tariffs still weighs on the investor community.

As overseas worries mount, all isn’t quiet on the home front, either. The Atlanta Fed’s GDP Now indicator predicts 2% U.S. growth in Q2, down from more than 3% in Q1. Market trends firm FactSet predicts a 2.5% slide in Q2 earnings per share for S&P 500 companies, which would mark the first time in three years that we’ve seen back-to-back quarterly EPS losses. Also, the Treasury market has been steadily rallying the last few weeks, which is kind of unusual in a stock market rally. It looks like investors continue to pile into “risk-off” assets like fixed income as they worry about the trade conflict, though no investment is truly “risk-free.” The 10-year Treasury yield fell to a 20-month low just above 2% yesterday, and then fell even more after the Fed meeting to its lowest levels since November 2016.

Amid all of this, it’s not quite clear that the Fed could ride to a quick rescue, but that’s the way stocks have acted. The S&P 500 Index (SPX) swaggered into today’s Fed meeting just about 1% below the all-time highs it posted back in late April. Keep in mind that any Fed rate move typically takes months, if not quarters, to work its way through the economy. 

Counting on the Fed

It might not be that people expect a rate cut to give the economy an immediate boost. It seems more like many investors just want the psychological lift of knowing the Fed stands ready to do what it has to in order to prevent a repeat of last fall. Back then, fears of a rate hike (which proved to be right) might have been a contributing factor helping take the SPX down nearly 20% between late September and late December.

About Those IPOs… It’s been a full spring for the Initial Public Offering (IPO) market, and so far the mixed performance of these former “unicorn” and now publicly-traded stocks roughly compares to the broader market. The clamor around these IPOs reflects the public’s big interest in new companies, and some of the fresh faces have scampered to huge early gains. However, there’s also a healthy bit of skepticism in the market, and it’s possible certain companies might have gotten a little ahead of themselves when it comes to stock price. In general, investors have mostly seemed to learn their lessons after the internet bubble of the early 2000s burst, and as most seasoned market watchers understand, nothing goes in a straight line up forever. That’s why it could be prudent to use a bit of caution trading these new stocks, and not go all in at once.

That said, the internet bubble was 20 years ago, so if you’re a 30-year old investor, you were 10 back then and probably not following Wall Street too closely (unless you were a pretty atypical kid). Sometimes a new generation has to learn old lessons, hopefully not the hard way.

How Times Have Changed: Talk of lowering rates seems a little surprising if you stand back and look at the overall economy. Sure, as we said above, U.S. GDP  growth does appear to be slowing and earnings growth is also flat to lower. Some overseas economies are shaky. Still, a lot of other signals point to continued strength, at least here in the U.S. The consumer continues to be a pretty positive factor, as we saw with last week’s retail sales report. Job growth has been strong, despite a recent fall-off from really surging growth earlier in the year, and unemployment is still at 50-year lows. 

That’s very different from how things were the last time the Fed cut rates on Dec. 16, 2008. At that point, unemployment was surging toward an ultimate high above 10%, the economy was bleeding hundreds of thousands of jobs a month, and crude oil prices had collapsed from above $145 a barrel in July to under $40 a barrel by December. That Fed easing took interest rates to effectively zero, where they stayed for seven years until December 2015. Since then, the Fed raised rates nine times under previous Chair Janet Yellen and current Chair Powell, back to levels previously seen in early 2008.

Focusing on Fundamentals: At times like these when trade-related headlines often move the market sharply one way or another (as we saw Tuesday), investors might want to consider staying focused on more of the fundamental economic factors and try not to get diverted too much by the latest events. Day-to-day news is still driving things in a major way. That can create big moves, and it punctuates the need to be careful and try to stick with your long-term goals and plans.We’re back near all-time highs and it’s nearly mid-year, so it might be a good time to examine your portfolio and see if it’s become more heavily weighted to stocks than planned. A rally can do that. We’re also getting close to earnings season, and earnings are the backbone of the market. Tariffs and trade wars might come and go, but earnings probably play a bigger role in the long run.

Information from TDA is not intended to be investment advice or construed as a recommendation or endorsement of any particular investment or investment strategy, and is for illustrative purposes only. Be sure to understand all risks involved with each strategy, including commission costs, before attempting to place any trade.

Image Sourced From Pixabay