The Fed did what everyone expected and left its key interest rates and policy guidance unchanged. Federal Reserve Chairman Jerome Powell made a similar point in his post-meeting press conference, saying that while he doubted further rate hikes, the Fed was considering raising rates ahead of its December 13th meeting. Problem: The current state of Fed policy is negative for the S&P 500.
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Stocks rose as the Fed’s statement was telegraphed without any concern, and were given further momentum by Powell’s remarks, but that may not last long. High borrowing costs have not yet dampened consumer spending or the job market. It may take a significant drop in the S&P 500 index to get the Fed back on track.
Mr. Powell presents mixed messages.
Powell left the Fed’s options open, repeating recent cautious comments that further tightening could be warranted if growth remains high.
“We will continue to make decisions meeting by meeting,” Powell said. He suggested that the Fed simply lacks confidence that further tightening will be necessary or can be avoided.
Powell said tighter financial conditions due to a rise in the 10-year Treasury yield may reduce the need for further rate hikes in the near term. However, he stressed that this will only happen if financial conditions remain tight.
Asked whether rising 10-year Treasury yields will ultimately succeed in slowing consumer spending, Powell emphasized that 30-year mortgage rates have reached 8%.
“The impact could be quite significant,” he says. He added that consumer research shows it is not a good time to buy durable goods.
Fed meeting policy statement
The Fed’s policy update included the same key language that has been reiterated at each meeting since May. The rate-setting committee will continue to assess “the extent of additional policy tightening that may be appropriate” to bring inflation back to 2%.
This does not imply a bias toward further rate hikes, but it does indicate that there is no consensus among policymakers that the Fed has done enough.
The Fed’s status quo means the economy is still too strong and inflation is too high, despite raising interest rates by 5.25 percentage points since March 2022. That’s because Fed policy isn’t working as expected.
Fed concerned about strong growth
A number of factors have slowed the effects of the most aggressive monetary tightening in more than 40 years.
Consumers saved an additional $2 trillion or so during the early days of the pandemic. A huge 8.7% increase in Social Security checks in January stepped up spending for the rapidly growing elderly population. Older people tend to borrow less later in life, so they are less affected by interest rate hikes. Most homeowners locked in low fixed mortgage rates before the Fed started raising rates, and S&P 500 companies similarly took advantage of the lowest rates possible.
Meanwhile, increased federal funding to the tune of $1 trillion is supporting a surge in investment in manufacturing, mining and infrastructure projects. Moreover, his strong rise in the S&P 500 index through July, fueled by the onset of the generative AI boom, significantly reversed the Fed’s tightening of financial conditions and increased household wealth and business investment.
Stress has come to the fore recently, with the 10-year Treasury yield rising to nearly 5% from less than 4% on July 31st. This has led to a nearly 8% rise in 30-year mortgage interest rates, leading to a sharp increase in applications for mortgage loans for home purchases. Subprime auto loan delinquencies have hit an all-time high, according to Fitch Ratings.
But because large parts of the economy are at least somewhat insulated from the effects of rising interest rates, the lag between Fed tightening and the full impact on the economy appears longer than usual.
S&P 500 index falls as 10-year government bond yield soars
As the Fed waits for its effects to take effect, it is slowing the pace of rate hikes and perhaps stopping them. But even if you are in a holding pattern, there will be further financial damage.
The problem for the S&P 500 is that the stock market is one of the parts of the economy most obviously exposed to high interest rates, especially the 10-year Treasury yield. Valuations of stock market price-to-earnings ratios depend in part on his 10-year yield, which analysts use to figure out what future earnings are currently worth. The higher the rate, the lower the paper rating.
The Fed has far more control over short-term interest rates than it does over the 10-year Treasury yield. That’s why the 10-year Treasury yield was around 4.81% just before the Fed’s announcement, well below the 5.25% to 5.5% range for the federal funds rate and the 5.07% 2-year Treasury yield.
But the Fed has contributed to the recent rise in 10-year Treasury yields in a variety of ways. The Fed is releasing $60 billion worth of U.S. Treasuries a month it bought early in the pandemic, increasing the supply of Treasuries available for sale to the public. This situation is expected to continue as long as the current situation persists.
Maintaining the status quo would mean higher borrowing costs and interest payments for the federal government, further increasing supply and exacerbating the unsustainable trajectory of the federal debt.
JOLTS, Treasury refund
Employers announced 9.553 million job openings in September, slightly more than expected, the Labor Department said Wednesday. The number of new users in August has been revised downward from the originally announced 9.61 million to 9.497 million.
The rate of job separation in the private sector remained at 2.6% for the third consecutive month. This is down from a peak of 3.3% to pre-pandemic levels, indicating that the labor market is easing.
The Treasury Department said early Wednesday that future bond sales will lean more towards short-term bonds, which could ease some pressure on 10-year Treasury yields.
The Treasury Department on Monday said it expected fourth-quarter borrowing to be $776 billion, down from its previous forecast of $852 billion, due in part to higher tax revenues. Borrowings in the first quarter of 2024 are expected to be $816 billion. This amount reflects both new borrowings and bond issuance to replace maturing bonds.
Fed focuses on 10-year Treasury yield
Many Fed officials have suggested that rising 10-year Treasury yields (assuming they continue) mean there is less need to raise the Fed’s short-term borrowing rates.
Reading between the lines, the Fed seems pretty content to keep the 10-year Treasury yield rising and keep putting pressure on the S&P 500 to accelerate the economic slowdown.
As Powell spoke, the S&P 500 extended its gains to 0.7% in Wednesday’s stock market, following a streak of gains earlier in the week. The yield on the 10-year U.S. Treasury note fell to 4.79% from 4.875% on Tuesday.
Be sure to read IBD’s The Big Picture column after each trading day to stay up to date on general trends in the stock market and what they mean for your trading decisions.
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