The Fed probably didn’t surprise too many when it left rates unchanged Wednesday. It pointed out what it said is strong economic and labor growth, while noting that inflation is near its 2% target.
(Wednesday Post-Fed) It’s steady as she goes for the Fed this time around, as many investors had pretty much baked in. After a June hike of the benchmark federal-funds rate to a range between 1.75% and 2%, the Fed concluded this week’s meeting Wednesday by standing pat and keeping rates right there.
The economy continues to look healthy by most measures, the Fed’s statement said, but rate policy remains “accommodative” to support what the Fed called “ strong labor market conditions and a sustained return to 2% inflation.” Still, the Fed arguably seems to be preparing investors for a possible rate hike by the time of its next meeting in September.
The Fed sees risks to the economy as “roughly balanced,” and said that “further gradual increases in the target range for the federal funds rate will be consistent with sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee’s symmetric 2 percent objective over the medium term.”
The statement was relatively short, leaving the impression that the Fed doesn’t have much new to say, at least not this time around. Just two weeks ago Fed Chairman Jerome Powell testified to Congress and laid out a similar set of remarks. The vote to keep rates unchanged was unanimous.
There really wasn’t much new insight from the Fed on Wednesday, at least not much that we haven’t heard before. The market continues to look for direction, but didn’t get too much from Powell and company.
The S&P 500 Index (SPX) was down going into the Fed’s announcement and sank further after the news. Still, it remained above the 2800 level where technical analysts see psychological support. Meanwhile, the benchmark 10-year Treasury yield, which hit 3% earlier in the day, traded at 2.99% in the minutes after the Fed statement. The two-year yield gained slightly on the 10-year, narrowing the spread between them.
The question heading into the meeting was less whether the Fed would hike (the futures market pegged odds at below 2%) and more about where rates might ultimately be headed. The Fed continues to indicate that it plans to raise rates in a way that keeps pace with a strengthening economy but not to levels where they might weaken growth. Where that “neutral” level might be remains a subject of debate.
The Fed’s challenge is to raise rates and inflation back toward historical norms without steering the economy into a recession due to higher borrowing costs. Remember, the Fed has a “dual mandate” of full employment and monetary stability, and right now, unemployment has been quite low and inflation has stayed in check. Whether this positive mix can continue remains to be seen. The Fed has pointed out tariffs as one possible impediment to growth, and any sign of overheating in the economy that moves the inflation dial could put pressure on the Fed to hike rates more quickly.
In June, the Fed’s “dot plot” predicted rates of 3.1% by the end of 2019, up a bit from the Fed’s 2.9% median estimate of a so-called “neutral” rate which neither supports nor slows the economy. The same dot plot expected rates to rise to 3.4% by the end of 2020.
However, Fed Chair Powell signaled that if the economic ship sails into any rocks along the way, perhaps due to factors beyond the Fed’s control such as tariff policy, the Fed might slow the rate of increase. Analysts note it could work the other way as well, Bloomberg News reported, meaning if the recent tax cuts stimulate faster-than-expected growth, the Fed might have to tighten more quickly.
With Personal Consumption Expenditure (PCE) prices up 2.2% year-over-year as of June, inflation appears to remain just above the Fed’s stated 2% target. However, the Fed has signaled it might let inflation run a little hot in an effort to avoid choking economic growth. With the economy growing 4.1% in Q2, the current rate regime doesn’t appear to be cutting off demand as of yet. However, the housing sector has struggled lately as prices rise and mortgages get more pricey, possibly a sign of higher borrowing costs starting to have an impact. Other economic data, however, continue to look mostly strong.
Now that the Fed’s decision is out, futures prices at the CME point to 90% odds of a rate hike by the time of the Fed’s next meeting in September, and a 66% chance of a fourth rate hike by the end of the year. Those odds are little changed from before the conclusion of this week’s meeting.
FIGURE 1: No Help From Fed: The S&P 500 (candlestick) was already down going into the Fed announcement and declined further after the news, as this one-day chart shows. The Nasdaq (purple line) out-performed the SPX through midday, buffered in part by Apple’s rally. Data Source: S&P Dow Jones Indices. Chart Source: The thinkorswim platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.
Empty Podium: This is going to be one of the very last Fed meetings to conclude without a press conference. Earlier this year, Fed Chair Jerome Powell announced that starting in 2019, press conferences will accompany each Federal Open Market Committee meeting, and that could arguably cause more volatility. Every time a Fed chairman speaks, especially when it’s a Q&A with the media or Congress, it raises the potential that he or she might say something market-moving. So enjoy the relative peace after this FOMC meeting, because someday you might look back fondly.
Target Practice: The Fed funds target rate is now between 1.75% and 2%, with the futures market expecting it to rise to between 2% and 2.25% by September. That puts rates at levels where the Fed historically has liked to see them, roughly between 2% and 5%. The question is how long this might last. It’s been a while since the Fed was able to keep rates in that range for long. For a year-and-a-half between late 2004 and mid-2006, rates climbed from 2% to 5%, but went over 5% in June 2006. Some people look back on the 1990s as a time of economic growth and strong stock markets, but rates were mostly above 5% for most of that period. Some Fed watchers argue that the so-called “neutral” interest rate might be lower now than in the past, but where exactly that is remains to be seen. Somewhere around 3% (the Fed’s current estimate) might be in the realm of possibility. The Fed’s “dot plot” sees rates reaching that level in 2020, but a lot can happen in two years.
Foreign Cuisine: The U.S. economy weighs heavily in the Fed’s rate decisions, but the background drumbeat of foreign economic performance also plays a big role. At this point, China’s growth engine seems to be encountering some headwinds, and the Shanghai Composite index is down more than 14% year-to-date. The Euro Stoxx 50 Index is also treading water this year, barely up at all since Jan. 1. Both the European Central Bank (ECB) and the Bank of Japan (BOJ) voted to keep rates unchanged at their recent meetings. That means the strong U.S. economy is a bit of an outlier. With German 10-year bund rates below 0.5%, there’s a wide gap with the 10-year U.S. Treasury yield, which touched 3% Wednesday. The Fed probably doesn’t want U.S. rates to diverge too widely from rates abroad, but it also doesn’t want inflation to get a foothold here. As you can see, Chairman Powell and company have a narrow tightrope to walk.
The TD Ameritrade Network is brought to you by TD Ameritrade Media Productions Company. TD Ameritrade Media Productions Company and TD Ameritrade, Inc. are separate but affiliated subsidiaries of TD Ameritrade Holding Corporation.
for thinkMoney ®
Financial Communications Society 2016
for Ticker Tape
Content Marketing Awards 2016
TD Ameritrade and all third parties mentioned are separate and unaffiliated companies, and are not responsible for each other’s policies or services.
Inclusion of specific security names in this commentary does not constitute a recommendation from TD Ameritrade to buy, sell, or hold.
Market volatility, volume, and system availability may delay account access and trade executions.
Past performance of a security or strategy does not guarantee future results or success.
Options are not suitable for all investors as the special risks inherent to options trading may expose investors to potentially rapid and substantial losses. Options trading subject to TD Ameritrade review and approval. Please read Characteristics and Risks of Standardized Options before investing in options.
Supporting documentation for any claims, comparisons, statistics, or other technical data will be supplied upon request.
The information 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. Clients must consider all relevant risk factors, including their own personal financial situations, before trading.
This is not an offer or solicitation in any jurisdiction where we are not authorized to do business or where such offer or solicitation would be contrary to the local laws and regulations of that jurisdiction, including, but not limited to persons residing in Australia, Canada, Hong Kong, Japan, Saudi Arabia, Singapore, UK, and the countries of the European Union.
TD Ameritrade, Inc., member FINRA/SIPC. TD Ameritrade is a trademark jointly owned by TD Ameritrade IP Company, Inc. and The Toronto-Dominion Bank. © 2018 TD Ameritrade.