Stocks Fall; Questions About the Fed's Path Forward

Friday, September 18, 2020 4:55 PM | Bobby Raines

Sept. 18, 2020 - The action in stocks has a decidedly before-and-after feel to it, although if you zoom out a bit, the week's overall action seems more like a continuation of the trend we've seen since the market's most-recent peak on Sept. 2.

While the turning point this week lines up with the Federal Reserve's policy announcement Wednesday afternoon from a chronological perspective, the popularity of blaming the Fed for swings in stocks seems overblown, and as we'll discuss in a moment, any hints towards less accommodative policy from the Fed are purely speculative at this point.

The fact is, after a massive rally in August, tech stocks have been leading the market lower in September. That trend resumed after the Fed meeting, but started well before. There was very little in the Fed's official statement, or in Chairman Jerome Powell's press conference that could reasonably have caused such a dramatic swing in stock prices.

We talked about the Federal Reserve in our workshop on Wednesday, noting that the expectation of the majority of policy makers is for interest rates to be at zero through 2023, even as the economy improves. We said Wednesday that while the short-term projections were in-line with the Fed's new policy approach of worrying less about inflation and more about more about employment, but as Nathan Tankus of Notes on the Crises highlighted this week the Fed's "longer run" forecasts show a return to 2% inflation and non-zero interest rates without any real hint at how we get from here to there. As Tankus points out, this is at least partially due to the lack of a clear definition for "longer run", but if the Fed is trying to signal that it's going to let inflation run hot to maximize employment, those forward forecasts are going to have to show above 2% inflation and low rates at some point.

Internet pundits aren't the only group concerned with the Fed's signaling. Neel Kashkari, the President of the Minneapolis Fed Bank and a voting memeber of the FOMC dissented from the September policy statement and posted about why. Kashkari articulates many of the same concerns we raised on Wednesday about the Fed's ability to stick to the new policy approach. It seems worth noting that Kashkari is the youngest voting member of the Open Markets Committee by two years, but the majority of voters are more than 10 years Kashkari's senior. The high inflation of the 1970s and early 1980s may carry more weight in the minds of the Baby Boomer members of the committee than it does for Kashkari.

One interesting note from Chairman Powell's press conference is that the Fed's projections assume additional economic support from fiscal policy makers (Congress). While there has been some movement from Congressional leaders this week, a new economic rescue package doesn't seem to be a particularly high priority.

That could change if economic data continues to weaken. After a series of upside surprises, this week's economic calendar contained a few notable misses. Numbers for industrial production and retail sales both fell short of estimates this week. Even the red-hot housing market showed some signs of slowing. Meanwhile, new claims for unemployment remain at exceptionally high levels and aren't falling nearly as quickly they were a few months ago.

More data will provide a clearer picture about how the economy is faring after the expiration of expanded unemployment benefits at the end of July and some other economic-support measures that ended over the summer.

While the major indices didn't go far this week, the internals are more interesting. The S&P 500 equal-weight index posted a gain of 0.85%, while the cap-weighted version lost ground. Most of the sector ETFs posted losses, although notably, financials, which have lagged for the entire recovery held up relatively well.

All told this week, the S&P 500 lost 0.64%, while the Nasdaq lost 0.56% and the Dow Jones ticked lower by 0.03%.

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