The Federal Reserve announced Wednesday that it will maintain its various programs that provide stimulus and support to the U.S. economy. Stocks have enjoyed a somewhat liquidity-driven run-up since late March and held onto their gains Tuesday.
Two themes the market already knew that the Fed confirmed Wednesday: the U.S. economy is headed into recession because of the Coronavirus pandemic and stimulus won’t relent until the country is out of the woods.
All three major U.S. indices rose Wednesday, with the S&P 500 rising 2.5%. The 10 year treasury yield had initially fallen to 0.61%, but then rose to 0.62%. The Fed had induced a quantitative easing program that includes purchases of longer-dated bonds, keeping those yields low, in order to keep borrowing costs down. But the slight move up in the yield shows that investors are willing, for the moment, to take incremental risk in stocks. Yields rise when prices fall.
The Fed said Wednesday that "The ongoing public health crisis will weigh heavily on economic activity, employment, and inflation in the near term, and poses considerable risks to the economic outlook over the medium term,” adding that it will maintain its 0% to 0.25% federal funds rate "until it is confident that the economy has weathered recent events.”
The Fed alluded to maintaining its programs to support the high yield bond market, both corporate and household, programs that more directly keep the cost of borrowing low across the economy.
These programs keep rates low and incentivizes borrowing to some degree for businesses and households that are receiving government checks and forgivable loans in the paycheck protection program.
As these programs have gotten underway and as lockdowns ease and virus vaccines make progress, stock investors have grown highly optimistic that the damage to the economy can be relatively muted and fast, as the market prices in a relatively swift recovery.
Since March 23, the S&P 500 has risen over 30% after hitting its bear market low. That has been accompanied by the 10 year treasury yield falling to 0.63% from 0.78%, a market movement consistent with the Fed’s massive liquidity injection.
Stocks can’t power much higher on the basis of monetary policy, which the Fed is merely confirming, not ramping up.
The path to a vaccine and the ending of lockdowns are the most important keys to uphold the current market expectation of recovered earnings.
Many on Wall Street look for near-term pullback, as the stock market is pricing in a somewhat brisk recovery, while the Fed noted Wednesday that the economic pain is for the “medium term,” not the short-term.
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