The Fed Keeps its Stimulus Promise, But Here’s the Problem -- ICYMI

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The Fed hinted subtly that the economic pain caused by the coronavirus outbreak may be under appreciated by the stock market

In its Wednesday announcement, the Fed said it will maintain its benchmark lending rate of 0% to 0.25%, keep credit flowing to households and businesses and continue to watch what is an ailing U.S economy. That’s code for, “we will do what it takes to steer the economy from depression until no further stimulus is needed.” Stimulus has come in unprecedented amounts and forms, with trillions of dollars injected into the short-term lending markets, high yield corporate bond markets and everything in between. 

The market is aware of the economic pain -- GDP contracted 4.8% for the first quarter and will likely contract more than 20% for the more representative second quarter -- as well as the Fed’s stimulus. 

Monetary and fiscal stimulus have aided the market's view that the recession will be more muted than initially thought and that a recovery will be closer to sharp than slow. The S&P 500 has rallied more than 30% from its March 23 bear market low, while the 10-year treasury yield has fallen from 0.78% to 0.63%, a sign both that investors are protecting against downside and that the rally is partially driven by liquidity and loosened financial conditions. 

But with stocks just 13% below their all-time highs and only down 8.6% year-to-date, the market is pricing in a fast recovery and sharp rebound. Meanwhile, the Fed said in its statement that the economic pain will be “medium-term,” not short-term, which would suggest stocks either need to stay put for a long time while earnings estimates catch up or pull back in the near-term to reflect uncertainty over earnings for the next year or two. 

“That is the right take by Powell,” said Matt Miskin, Co-Chief Investment Strategist at John Hancock Investment Management. “This is going to take several months and potentially until the third quarter. Our view is that this is going to take into the fourth quarter to get this recovery back up and running. In terms of the market, we think we’ve gotten much of the returns we were expecting for the year in the last couple of weeks.” 

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