The Fed Remains Steady -- a Recap of Interest Rate Policy of Late (It’s Lifting Stocks) -- ICYMI

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The Federal Reserve said in its January minutes, released Wednesday, that it will hold interest rates steady for the foreseeable future and stocks rose. But its message of the last several months -- that it will lower rates if need be -- is unchanged, enabling more stock buying Wednesday.

All three major U.S. stock indexes rose Wednesday, with the S&P 500 up as much as 0.6% on the day.

Federal Reserve Chairman Jerome Powell said the central bank will act “as appropriate” going forward. On the negative economic impact of the coronavirus in China, Philadelphia Fed President Patrick Harker said, “if the situation gets significantly worse and we start to see a significant impact on the U.S. economy then we’d have to think about accommodation.”

The U.S. is unlikely to see a major impact to growth from the virus, although if manufacturers in China shut down again to slow the spread of the virus, that could change. “For U.S. companies that rely on intermediate goods originating from China, product shortages could hamstring their efforts to conduct business-as-usual. For now, companies will make use of existing inventories, but such buffers are dwindling fast,” said Jason Pride, chief investment officer of private wealth at Glenmede. Apple warned earlier this week that it will miss revenue guidance for the quarter because of the effect of the virus on its manufacturing in China and on customers there.

U.S. stock investors have looked past the virus and appear confident that should growth decelerate again — for any reason — the Fed is there to provide stimulus.

Here’s a recap of monetary policy in the past several months.

After three rate cuts in 2019, the Fed is now watching the impact of that stimulus on the economy.

Many were initially looking for further deceleration of GDP growth and inflation to below 2% in 2020 but are now looking for those numbers to remain at roughly 2%.

In the mid-November meeting, Powell noted that monetary policy often operates on a lag, which means higher consumer and business spending can take some time to tick up after rate cuts. The Fed held rates steady at that meeting but said it will cut if need be. The S&P 500 has risen 9.5% since that date.

In mid-December, Canaccord Genuity’s chief market strategist Tony Dwyer said in a note that that “housing data suggests lower rates [are] working.” The National Association of Homebuilders' monthly survey, according to Dwyer, had posted a 20-year high of 76, on a scale of zero to one hundred. And the survey showed the largest month-over-month gain in overall housing sales since 2013. Home sales can be a particularly positive economic indicator, as more home purchases are not only a sign of cyclical strength but lead people to shop more for items needed in their new houses.

On January 28, the Fed said it was keeping rates steady. The S&P 500 has risen 3.4% since then.

The probability of another rate cut soon in 2020 is 10%, according to data from the CME Group, but that 10% may be prone to move up.

The bond market may be signaling to the Fed that rate cuts should be in the cards sooner rather than later.

“Two-year yields, which we view as a proxy for expected monetary policy, typically follow the fed funds rate unless fixed-income investors expected a rate change in the near term,” wrote LPL Financial strategists in a research note.

An LPL graph shows that all three rate cuts in 2019 were preceded by a slip in the two-year treasury yield below the fed funds rate range. The 2-year treasury is currently yielding 1.42%, below the federal funds rate of between 1.5% and 1.75%.

Importantly, the stock market rally has recently been led by growth stocks like Microsoft MSFT, Amazon AMZN and Apple, as well as defensive bond-proxies like utilities. Meanwhile, the 10-year and 3-month treasuries are inverted again, signaling bearishness on growth and the need for a rate cut.

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