CWS Market Review – June 16, 2021

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I wanted to send you an update on today’s Federal Reserve meeting. This was an important meeting and the stock market dropped for the second day in a row. This was actually the largest daily drop for the S&P 500 in a month. That probably says more about the placidity of the last month than it does about today.

As I’ve discussed before, the Fed’s decisions are becoming increasingly important to us as investors. That’s because during the pandemic, the central bank took extraordinary measures to help the economy. Not only are interest rates near 0% but the Fed has been buying $120 billion in bonds every month.

Now that the economy is improving and life is returning to something resembling normal, there’s growing pressure on the Fed to pare back its enormous stimulus. Adding to this has been higher inflation which hasn’t been a major factor in the U.S. for 40 years.

I should warn you that central bankers aren’t big fans of plain English. They prefer to speak in the arcane language of Fedspeak. Fortunately for us, dear reader, your humble editor is well-versed in Fedspeak and I’ll help translate for you.

Having said that, here’s today’s statement:

The Federal Reserve is committed to using its full range of tools to support the U.S. economy in this challenging time, thereby promoting its maximum employment and price stability goals.

Progress on vaccinations has reduced the spread of COVID-19 in the United States. Amid this progress and strong policy support, indicators of economic activity and employment have strengthened. The sectors most adversely affected by the pandemic remain weak but have shown improvement. Inflation has risen, largely reflecting transitory factors. Overall financial conditions remain accommodative, in part reflecting policy measures to support the economy and the flow of credit to U.S. households and businesses.

The path of the economy will depend significantly on the course of the virus. Progress on vaccinations will likely continue to reduce the effects of the public health crisis on the economy, but risks to the economic outlook remain.

The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run. With inflation having run persistently below this longer-run goal, the Committee will aim to achieve inflation moderately above 2 percent for some time so that inflation averages 2 percent over time and longer term inflation expectations remain well anchored at 2 percent. The Committee expects to maintain an accommodative stance of monetary policy until these outcomes are achieved. The Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and expects it will be appropriate to maintain this target range until labor market conditions have reached levels consistent with the Committee’s assessments of maximum employment and inflation has risen to 2 percent and is on track to moderately exceed 2 percent for some time. In addition, the Federal Reserve will continue to increase its holdings of Treasury securities by at least $80 billion per month and of agency mortgage backed securities by at least $40 billion per month until substantial further progress has been made toward the Committee’s maximum employment and price stability goals. These asset purchases help foster smooth market functioning and accommodative financial conditions, thereby supporting the flow of credit to households and businesses.

In assessing the appropriate stance of monetary policy, the Committee will continue to monitor the implications of incoming information for the economic outlook. The Committee would be prepared to adjust the stance of monetary policy as appropriate if risks emerge that could impede the attainment of the Committee’s goals. The Committee’s assessments will take into account a wide range of information, including readings on public health, labor market conditions, inflation pressures and inflation expectations, and financial and international developments.

My Take on Today’s Fed Meeting

So, what the heck does all this mean? Let’s start at the top. First, the Fed said that economic activity has strengthened. The Fed also didn’t make any changes to interest rates. The target for the Fed funds rate is still near 0%. The Fed is also going to continue to buy $80 billion a month in Treasuries and $40 billion a month in mortgage-backed securities. That’s a gigantic amount. By the way, the vote today was unanimous.

I think it’s likely that at some point soon, the Fed will start tapering its bond buying. Meaning, they’ll still be raking in bonds but at gradually smaller amounts.

Here’s the problem: this is what the Fed did eight years ago. The Fed Chief at the time was Ben Bernanke and he mentioned tapering en passant at a Congressional hearing. The bond market totally freaked out. Bonds dropped and yields soared. This become known as the infamous “Taper Tantum.” The Powell Fed wants to avoid that.

That’s why the Fed said it won’t make any changes to its bond buying until “substantial further progress has been made.” The Fed is trying to send a message that they’re not about to cut and run. Of course, this starts another debate of what exactly “substantial” means. Still, I think there’s a good chance that the Fed will announce its tapering plans in late summer. At the end of August, the Fed will host its annual shindig at Jackson Hole, WY. That might be the best opportunity.

About inflation, the Fed noted that inflation is rising but reiterated that it thinks it is “transitory.” That’s basically what it said last time. I hope the Fed is right about that. We’ve seen prices for some commodities start to fall. Lumber, in particular, has been dropping hard.

It looks like a meme stock!

Now let’s turn to the Fed’s economic projections. The Fed increased its forecast for inflation for this year from 2.4% to 3.4%. That’s a big increase considering the year is nearly half over. By 2022, the Fed sees inflation falling back to 2%.

The Fed raised its GDP outlook for this year from 6.5 to 7%. The forecast for unemployment at the end of this year is unchanged at 4.5%. Frankly, I think that’s way too optimistic, but I hope it’s correct. The Fed even sees unemployment dropping to 3.5% by 2023. In other words, we’ll have steady inflation and low unemployment. So the Fed think its policies will be a roaring success!

Now here’s the big change. Seven of 18 Fed officials see a rate hike coming sometime next year. That’s up from four at the last meeting. Specifically, five voters see one hike this year and two see two hikes. Previously, three saw one hike and one saw two.

The market took this as a hawkish statement. Almost immediately, the Dow fell 200 points. At its low, the S&P 500 was down more than 1% and the yield on the 10-year Treasury rose seven basis points.

Here’s a minute-by-minute chart of the S&P 500 today. You can tell the Fed released its statement at 2 p.m.

I should explain that there are currently 18 members on the Federal Open Market Committee. However, not all of them are currently voting members. The regional bank presidents rotate as voting members. As a result, those seven votes probably overstate the desire of the Fed to hike rates. Bear in mind, we’re debating a 0.25% rate increase coming 18 months from now. I just don’t think that’s something to worry about.

Jerome Powell even said in his press conference to not read too much into the economic projections. I would go even further. I question the usefulness of the Fed releasing its economic projections. If you release them, then the market will take it seriously. That’s how markets act. But don’t release the projections and then say “well, it’s no big deal.”

The bottom line is that the Fed is still on the side of investors. Rates will stay low and the bond buying will continue. This has been good for stock investors and I expect it will continue to be. At some point, the Fed will “take away the punchbowl from the party,” but we’re not there yet.

That’s all for now. I’ll have more for you in the next issue of CWS Market Review.

– Eddy

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