Message In A Bottle

Message in a bottle.  Stocks had a wild day yesterday, giving up early gains in a mixed close as tech shares continue to suffer.  The Fed says rates will remain lower for longer but calls out lawmakers as a necessary component on the road to economic recovery.

N O T E W O R T H Y

Connecting the dots.  It came and went.  The last opportunity came for the most powerful bank in the world to set economic expectations and policy before what is expected to be a contentious election.  The result of the meeting was hardly a surprise, but stock traders chose the opportunity to vote their disappointment by selling off into the close.  Why were they disappointed?  Let’s go through the events of the day.  Early in the session, stocks were up in anticipation of more dovish talk by the Fed… except for megacap tech stocks which continued to lag the broader market.  While the slip in techs is disappointing to some, the group’s recent pullback comes after an unhealthy period of outsized gains brought on by a frenzy of speculative option buying.  In other words, technology appears to be reverting to the mean, which is normal and healthy.  Regarding everything else, it was the Fed that set the tone in yesterday’s trade.  Let’s start with policy.  The Fed expectedly kept rates unchanged and it will maintain the current pace of the QE bond buying.  In its policy statement, it did not make any notable changes.  All of that was largely expected and the markets’ initial response was somewhat positive. What traders were really looking forward to was forward guidance, as I outlined in yesterday’s note.. and that they received.   The Fed releases “projection materials” several times a year, and amongst them is the infamous Dot Plot, which basically displays FOMC members’ projections for Fed Funds rates over the next few years.  Though there are many detractors of the chart, it is an important gauge of the most powerful economists’ current views.  They, after all, are responsible for setting monetary policy, so I would say knowing their projections on that very thing that they vote on is, well, a good thing.  I have attached the current Dot Plot (courtesy of my Bloomberg) for you to see for yourself.  The horizontal axis represents time, and this Dot Plot is the first to go out 3 years into the future.  This is part of the Fed’s attempt to provide more guidance.  The vertical axis represents the Fed Funds rate in percentage.  On the chart, each dot represents a FOMC members projection for rates in a particular year.  You won’t have to look too closely to note that almost every member expects rates to remain near zero through 2023.  That is a powerful statement and one which was not entirely unexpected by the market.  On the attached chart, the yellow dots represent yesterday’s projections, while the gray dots represent the committee’s projections from their June meeting.  By comparing the two, you will note that since June, the committee has appeared to push their projected rate takeoff date out by 1 year, but in fact the prior plot did not give 3 years’ worth of guidance, so 2023 was included in the very nebulous and highly un-useful “longer term” category. However this new projection tells us that most members expect rates to be near 0% in 2023 as well.  This brings us to the committee’s description of the economy.  It saw a larger than expected increase in economic growth in the past quarter with small pick-ups in consumption and business investment, both good.  This has led the FOMC to upgrade their annual GDP projections to a decline of -3.7% versus its earlier projection of a -6.5% annual pullback.  So far so good.  Lower interest rates for longer and the economy has recovered quicker than expected this year.  Unfortunately, the Fed believes that the better-than-expected growth will not continue and has downgraded its growth forecasts for 2021 and 2022. When pressed on the reasons for the downgrade, the Chairman cited a lack of monetary policy being one of the largest risk contributors.  In other words, Congress’ inability to agree on further stimulus risks stunting the current rate of recovery.  If lawmakers didn’t get the message, the markets certainly did as stocks sold off promptly. The statement was surely not a revelation and markets have been on edge regarding further stimulus, but the Chairman's answer along with the downgraded forecasts spurred a selloff.  Finally, the Fed, as expected, has made it clear that interest rates will remain low and that accommodative policy will continue until BOTH average inflation gets to a 2% target AND employment returns to normal. Normal was not defined, but it is assumed that unemployment must be below 5%, which the Fed is not expecting until at least 2023.  Both Senate and House leaders will meet today to further discuss a follow-on stimulus package.  Though there appears to be no clear path as of yet, the recent market reaction to a lack of progress may serve to clear up the logjam.

THE MARKETS

Stocks had a mixed close yesterday as indexes gave up large earlier gains in response to the Fed Chairman’s press conference.  Traders were reminded that the path to recovery is going to be longer and require a yet-to-be-agreed-upon stimulus package.  The S&P500 gave up -0.46%, the Dow Jones Industrial Average gained +0.13%, the Russell 2000 Index added +0.92%, and the Nasdaq Composite Index dropped by -1.25%.  Bonds slipped for a second day and 10-year treasury yields gained +2 basis points to 0.69%.

NXT UP

- Initial Jobless Claims (Sept 12) are expected to come in at +850K compared to last week’s 884K.

- Continuing Jobless Claims (Sept 5) are expected to show a slight decrease to 1.488 million from 1.496 million.

- Housing Starts (Aug) may have contracted by -0.6% compared to last month’s explosive +22.6% growth.

- Building Permits (Aug) are expected to have grown by +2.0%, slower than the prior month’s +17.9% revised growth.

- Philadelphia Fed Business Outlook (Sept) is expected to have declined to 15.0 from 17.2.

daily chartbook 2020-09-17