As Expected: Fed Keeps Rates Unchanged and Forecasts Years Of Dovish Policy

(Wednesday Post-Fed) There you have it. The Fed stood pat today after lowering rates to essentially zero earlier this year. It expects to keep them there for a long, long time. 

And in the post-meeting press conference, Fed Chair Powell didn’t exactly bury the lead, opening with the central bank’s commitment to do “whatever we can, for as long as it takes” to put the economy on solid footing. 

This non-move shouldn’t be a surprise, because the futures market pointed to very low odds of any rate hike and the Fed itself has said it won’t raise rates until the economy is well along the road to improvement. In its forecast today, the Fed envisioned rates remaining near zero through 2022, so at least another two years. 

What progress has the economy made, if any? That’s what many investors wanted to get the Fed’s perspective on as the central bank’s June meeting ended today. In its latest statement, the Fed said it sees gross domestic product (GDP) shrinking 6.5% this year amid the ravages of COVID-19 before bouncing back with 5% growth next year and 3.5% growth in 2022. The Fed’s core inflation forecasts look pretty weak, staying below 2% through 2022. 

The Fed expects unemployment to average 9.3% this year, 6.5% next year, and 5.5% the year after. None of these levels would be near the “full employment” the Fed has said it wants to see on the near horizon before raising rates. Full employment is a moving target, but generally economists see it as being below 5%. 

Cautious Optimism Conveyed

It’s good to see the Fed forecasting steady economic improvement over the next few years, even though pessimists might still say the Fed can’t anticipate any possible surge in the virus that might cause the economy to step back. Still, it can only work with what it knows, and as Fed Chairman Jerome Powell has said, Fed officials aren’t medical diagnosticians. 

“Financial conditions have improved, in part reflecting policy measures to support the economy and the flow of credit to US households and businesses,” the Fed said in its statement. So apparently the stimulus and dovish policy is starting to take effect, something last week’s jobs report and some other recent economic data seemed to point toward.

Many investors also are probably scrutinizing the Fed’s language today for any sign of the central bank pressing the brakes even the slightest bit on its accommodative strategy. Worries the Fed might get less dovish surfaced after last Friday’s payrolls report revealed surprisingly strong May jobs growth. From a quick look, it doesn’t sound like any hawkish language crept in. 

Stocks entered meeting time in mixed shape, with the Dow Jones Industrial Average ($DJI) down more than 100 points as Boeing (BA) weakness continued, but the Nasdaq (COMP) still pulling at the leash amid semiconductor and Apple (AAPL) strength. The S&P 500 Index (SPX) was roughly flat. So pretty much the same pattern as yesterday.

The market initially lost ground after the Fed decision, then traded mixed. On the one hand, It could be helpful for stocks that the Fed expects economic growth to post some decent numbers the next two years, though keep in mind that with a 6.5% decline this year, that growth will be from a lower base. That means getting back to last year’s GDP—and earnings—levels could take longer than a year or two. 

The fact that the Fed isn’t forecasting any rate increases over the next two years also might be viewed as decent news, though it wasn’t unexpected. Bank stocks, however, got hit hard after the Fed meeting, as low rates tend to hit their profit margins.

Weak performance by the Financial sector might be another reason the $DJI is under pressure this afternoon, and the Russell 2000 (RUT) index of small caps, which is heavily exposed to regional banks, is also on the move lower.

Investors continued to roll back into bonds this afternoon, as the 10-year Treasury yield sank to 0.77%. Late last week it touched 0.9% as economic optimism percolated. If the Fed is set on keeping rates historically low for at least two more years and continue its fixed income purchases, that’s not exactly an invite to sell bonds.

Connecting the Dots

For the first time in six months, investors today got a look at a fresh Fed  “dot-plot” of rate expectations. This tool provides a forecast of Fed officials’ individual expectations for the rate path over the next two to three years. 

While the Fed normally releases a dot-plot once per quarter, that wasn’t the case in Q1 when the regular meeting got canceled as the pandemic raged and the Fed pushed through two emergency rate cuts. Those rate rollbacks took the Fed funds rate down from a range of between 1.5% and 1.75% at the start of the year to between zero and 0.25% where it stands now. 

So where do the dots point for 2021 and 2022? Almost no Fed member anticipates rate hikes between now and the end of that period. In the dot plots of each members’ forecasts, only two saw a case for hiking rates in 2022. The rest see rates standing right where they are.

Going into the meeting, there were almost no expectations of any rate changes today. Instead, the focus was on what the Fed’s statement would say about the current health of the economy and how quickly growth might return.

“A full recovery is unlikely to occur until people are confident that it’s safe to engage in a wide array of activities,” Powell said in his post-meeting press conference. He added that the Fed plans to use tools like zero interest rates and asset purchases, “forcefully, proactively, and aggressively until we’re confident we’re on the road to recovery. When the crisis ends, we’ll put the tools back in the box.”

Powell emphasized that the Fed doesn’t have the power to tax and spend, and said, as he has in the past, that more fiscal stimulus from Congress might be needed.

Powell called last week’s payrolls report, “A welcome surprise,” adding that “we were very pleased and hope we get a lot more like it.” Still, he added, even if a number of reports like that come out, there will still be a huge number of unemployed and the Fed will need to continue providing policy support to help those people. “It’s a long road,” he said.

Ramping Up the Balance Sheet

The other question was how much more ammunition the Fed would consider firing up in its attempts to keep the economy from sliding further into the doldrums. Between March and now, the Fed’s balance sheet has risen by about $3 trillion, swelling it to more than $7 trillion. That’s way above the previous peak of $4.5 trillion in early 2015 following the financial crisis. 

In its statement, the Fed restated its commitment to continuing to increase its bond holdings, with Treasury purchases of $80 billion a month and mortgage-backed securities of $40 billion. This, Powell said in his press conference, will help sustain orderly market conditions.

Some economists worry that the higher balance sheet—accompanied by fiscal stimulus from Congress and the White House that also went through this year—could trigger inflation at some point, though Powell has said inflation isn’t really a worry of his now. Today’s consumer price index (CPI) reading for May of negative-0.1% revealed a very quiet inflationary picture, which isn’t surprising considering the high unemployment rate. The annual “core” CPI is up just 1.2%.

With inflation looking so weak long-term, Powell quipped, “We’re not thinking about raising interest rates or even thinking about thinking about raising rates.”

CHART OF THE DAY:  GREENBACK RED. Aside from one flattish Friday, the U.S. Dollar Index ($DXY) hasn’t seen an uptick since Memorial Day. Next stop? Some chart watchers might point to the March low close of 95.06 and the intraday low of 94.65 as possible support. Data source: ICE Data Services. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.

Unbalanced Scales: No one’s really arguing that the major indices reflect earnings in any normal kind of way right now. In fact, a recent CNBC poll of analysts showed nearly 80% of them thought stocks were high compared with analysts’ earnings and economic growth estimates. Over the past 11 weeks, the S&P 500 Index (SPX) has surged 43%, pushing its price-to-earnings (P/E) ratio for the next 12 months above the 25 level, according to S&P Capital IQ consensus estimates. The last time the market traded at this extreme was in the early months of the 2000–02 bear market, research firm CFRA said. That 25 multiple represents a 52% premium to the average P/E since 2000. 

It’s also higher than the P/E coming out of the 2008 financial crisis, CFRA said. Eventually, these things have a way of working out. Either companies will begin putting out some upward revisions to earnings estimates that could help justify these price levels, or stocks could catch a summer cold. However, some would argue that even without improved earnings outlooks,  the Fed tailwind might be enough to keep stocks as hot as July.

Act Two: A lot of companies start with a big bang and then find ways to have a second act with something different as they mature. Think about Microsoft Corporation MSFT and Amazon.com Inc AMZN, for instance, and how they became cloud companies, or, in the case of AMZN, also went into the grocery store business. They’re still churning along with the businesses we all know so well, but also checking what else is out there. Facebook Inc FB is also doing something different with its Facebook Shops initiative. This is a really interesting product and it got mentioned in a positive analyst note yesterday. It could deliver a lot more advertising into the FB site, and perhaps take ad-spend away from competitors like AMZN and Ebay Inc EBAY. FB is trying to be all things to all people, with a place to shop and being a “third screen” for people to turn to, say during a sporting event. This is an example of a company not exactly thinking outside of the box, but taking ideas and trying to improve them.

For now, Netflix Inc NFLX arguably hasn’t really moved the needle far beyond its original line of business, so it could be worth watching to see if that company has a second act. In the meantime, NFLX continues to impress with its existing product. A recent news item said only a very small percentage of people who signed up for Disney+ —Walt Disney’s DIS new streaming service—dropped their NFLX subscriptions.

Time for a Check-Up: It’s almost mid-year and the stock market is back to basically where it was on Jan. 1 after a wild ride. Investors doing their mid-year portfolio check-ups might find themselves back to even with the end of 2019, meaning in the same place as far as equity to fixed income ratio. Or perhaps not. If you have big positions in some of the FAANG stocks like Apple Inc AAPL and Netflix but aren’t exposed as much to the rest of the market, it’s possible this recent rally might have you out over your skis a bit as far as stock exposure. 

Info Tech is up about 15% over the last three months, compared with less than 9% for the SPX in that same time span. Though it’s just a few weeks since we were reminding people to check whether the selloff in stocks had put their portfolios into a more bond-heavy ratio than they might have wanted, the opposite might be true now after this huge run-up, meaning some investors might want to consider trimming their stock sails a bit—if they see their exposure to equities trending above plan, that is.

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