Investors prefer a situation where the Fed does not see a need to act over when they act to cool the economy. They chose to stand aside again, and some found this a little scary.
2018 wasn’t such a great year for the stock market, and a lot of this had to do with the Federal Reserve’s tightening of the economy. To them, things looked too much like they might be getting out of control, which was met with interest rate hikes to cool off the economy.
There was also the matter of the $4.5 trillion in assets that the Fed has had in cold storage for a long time now, mostly from the huge buying spree they did to try to help us out of the Great Recession. This, along with dropping their interest rates to near zero, serves to increase the money supply and serve as an economic stimulus, and the times called for the big weapons and these were indeed the biggest.
We’re well past this recession though, and rates have gone up since. Rates going up is quite bearish for stocks, and after putting in a year where we essentially traded water year over year and saw a 20% drop during the final quarter, and with the economy cooling down enough to satisfy the hawks at the Fed who wanted to do more, we were finally told that they will be laying off us for a while.
Stock markets responded by putting in a nice rally, and the economy continued to show more signs of slowing. We were told in December that we should expect two more rate hikes in 2019, which later become revised to probably just one as the need for this intervention waned.
The Fed finally decided to reduce its balance sheet gradually, something that really needs to be done sooner or later. Given that adding to it stimulates the economy, reducing it needs to be done with care so that we don’t end up with too restricting of an effect upon money supply. This is like taking some of the Fed’s money off the table, whether that be by actively selling part of their position or taking a more relaxed and passive approach and just letting issues expire without being renewed.
The Fed chose the less aggressive approach, a run-off, and this happens gradually enough that it doesn’t cause the market shocks that are feared by their just dumping securities on the market, but the fact that they waited as long as they did to do this tells us that this still needs to be used with care.
During the current meeting of the Fed’s Open Market Committee, the one that we get announcements such as interest rate hikes or cuts as well as an official view of where the central bank stands, this one at least appeared to be quite investor friendly indeed, at least as far as policy issues are concerned.
This Report Had No Real Negatives and Some Positives
There was no real expectation of another interest rate hike, and although we were told that we’d be in store for one this year, few expected that this would be the meeting where we would see it. This is in spite of evidence that several committee members were leaning toward one last time, because things have cooled even more since then.
We have now learned that the Fed has reduced the number of interest rate hikes that they plan on doing in 2019 to zero, although that wasn’t really much of a surprise as well, but certainly good news for the stock market. The economic numbers tell the story here, especially the ones that the Fed gives us, and it really doesn’t take all that much insight to figure out that this is not a situation that seems to require our present level of growth to be restrained.
This view also extended to the Fed’s current program of running off their balance sheet, which is now scheduled to be put on pause in September. This is akin to their looking to stop taking money out of circulation. Their buying of securities to stimulate the economy is called quantitative easing, and the unwinding of these positions is called quantitative tightening, tightening the money supply. More money in circulation stimulates it, less money contracts it, and while they aren’t planning on doing more easing, they have decided to put tightening on hold.
This is more of a middle ground position actually but is one that is more friendly to economic growth. The Fed has gone from brandishing their swords to putting them all away now, and the stock market hates swords and even the threat of them.
It’s hard to imagine how this meeting could have gone better from the view of the stock market, aside from an interest rate cut, which most feel that isn’t really on the table yet. Other than that, this meeting had the Fed bending over backwards to make the stock market happy, or it would seem anyway, even though that’s really not their focus, it’s the economy itself that they are concerned with.
We’re Slowing Down, But in A Controlled Manner So Far
When news like this comes out, even though it may meet consensus expectations, there is still a sigh of relief that comes out because you never really know exactly what will happen with open market committee meetings. As a rule, market friendly announcements get met with a thumbs up and a rally, where unfriendly ones have investors running for the exits more.
This time, the news was good but the response wasn’t so positive. Both the Dow and the S&P ended up down fairly significantly. While there are other factors involved of course, we heard the news, and we then moved down, so it was pretty clear that this was not met with much favor at all.
While we are left to speculate as to why this happened, the consensus is that the Fed rolling over like this is scaring some people, especially those who see us moving into a recession soon. It does make sense that if you’re worried about a recession and the Fed is acting more like there might be one by laying off so much, then your fears can at least somewhat be confirmed.
We do need to realize that this response by the Fed is entirely reasonable. This is not the time to be looking to slow down the economy on purpose. If and when we have good evidence to think that this will be needed, that’s another matter, but this is not now under any measure really.
This FOMC meeting was more of a non-event, and really doesn’t have any bad news to tell, or much news of any type actually. We are left with the positivity of those who wanted to raise rates being at least silenced, if not converted. Given that the forecasts from the last meeting have moved more toward the side of slowing, anything else would be a real surprise, to the extent that we may worry what these people are looking at to maintain this view.
There may have been some who actually were expecting a rate cut and got disappointed, but the fact that things haven’t got this bad that this is even realistic now should actually serve to have us consoled by this meeting, not frightened. If it’s not time to call the fire department yet, then the fire can’t really be that out of control.
The Fed did announce that they dropped their forecasts for GDP growth from 2.3% to 2.1% for 2019, but we already knew that. While trending down like this may not be a good thing, the models for 2019, 2020, and 2021 all have us coming in around this area, and this is not an unhealthy number. This also forecasts real stability, a clear positive, especially for those who fear a downward spiral.
While there may not be that much out there to want us to break out of the sideways pattern in the markets we’ve been in and shoot things higher, there’s nothing here that should be taking us downward very much either, even though some investors and traders may have acted a little skittish after this announcement.
We’re now back to business as usual with no real change and we can get back to all the other things that we worry about day-to-day, including the economy. The economy isn’t really going that badly though, and not enough for the Fed to want to do anything right now, and that should comfort us at least a bit.