Fed Rate Hike Is No Surprise, But Stock Market Weakens On Powell, 2019 Outlook – Investor's Business Daily

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The Fed hiked its key interest rate on Wednesday, surprising no one, while signaling no rush to step up its gradual pace of monetary tightening this year. The S&P 500 index and other major averages, after initially extending modest pre-announcement gains, then weakened as Jerome Powell held his first post-meeting news conference as Federal Reserve chairman.

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The initial market focus was on the Fed’s near-term policy trajectory, but the takeaway may not be quite so positive once investors digest the more hawkish long-term outlook which hints at concern that there’s greater risk of the economy overheating.

As in December, the quarterly economic projections reflecting the individual views of each Federal Reserve policymaker pointed to a likelihood of three quarter-point rate hikes in 2018, not four, as Goldman Sachs and some other Wall Street firms anticipate. But the Fed did step up its rate-hike outlook for 2019.

Fed policymakers now expect three quarter-point rate hikes in 2019, up from two in December, as the jobless rate falls to 3.6% in 2019 and core inflation rises to 2.1%, just above the Fed’s target.

The Fed’s patience could give stocks a bit of running room as policymakers await evidence that faster economic growth, fueled by the big Trump tax cut and spending increases that have yet to hit, will boost wage growth and inflation.

Powell said that if the Fed hikes too fast, “inflation doesn’t get up to 2%.”

Stock Market Pares Gains

The Dow Jones industrial average, S&P 500 index and Nasdaq composite initially extended moderate gains following the 2 p.m. ET policy statement. But after Powell began speaking at 2:30 p.m. ET, the Nasdaq  leading the averages into negative territory in the stock market today. The Dow Jones and S&P 500 fell 0.2% while the Nasdaq lost 0.3%. However, the small-cap Russell 2000 managed to climb 0.6%.

The S&P 500 and Dow Jones remain below their 50-day moving averages, while the Nasdaq recently found support at that key level. Bank stocks were among the gainers after the Fed meeting, thanks to signals that policymakers are willing to let the economy run at least a little hotter.

The 10-year Treasury yield initially slipped after the announcement, then turned higher to about 2.92%, before backtracking as stocks weakened. The yield is not too far off the key 3% threshold that hasn’t been breached in more than four years.
If there’s one reason why stocks turned lower as Powell spoke, it could be because of his discussion of the significance of the Fed, for the first time, expecting above-target core inflation of 2.1%. The forecast raises the question of whether the Fed may really think of the 2% inflation target as symmetric — meaning that the current undershoot should be balanced out by a future overshoot.

Yet Powell, in his press conference, said policymakers will aim to avoid any “sustained or persistent deviations.”

“We’re always going to be seeking 2%.”

Investors probably shouldn’t be too reassured by a largely status-quo announcement on 2018 policy from the Fed. There’s good reason to expect policymakers to step up their expectations to four 2018 Fed rate hikes by June — even if inflation remains tame.

Once a pickup in wage growth materializes — and it’s very likely to this spring after wage hikes by Walmart (WMT), Target (TGT), CVS Health (CVS), Starbucks (SBUX), FedEx (FDX), JPMorgan Chase (JPM), Bank of America (BAC), Wells Fargo (WFC) and others — Fed members will likely adjust rate-hike expectations upward.

The Fed’s most influential dove, Lael Brainard, in 2017 explained earlier this month why low inflation won’t prevent a more hawkish policy turn: Policymakers need to stay “vigilant” to contain any financial-system excesses.

Unemployment appears on course to fall to rarely seen levels that tend to come with “elevated risks of imbalances, whether in the form of high inflation in earlier decades or of financial imbalances in recent decades,” Fed Governor Brainard said, alluding to the dot-com and housing bubbles.

Brainard echoed new Fed Chairman Jerome Powell’s congressional testimony last month that economic headwinds have turned to tailwinds. Powell said there was still no evidence in the data that stronger growth has led to an acceleration in wage gains, which Fed theory sees as a precursor of upward price inflation.

Brainard noted, “While asset valuations appear to be elevated, overall risks to the financial system remain moderate because household borrowing is moderate” and the banking system is “well-capitalized” after financial reforms. Still, she said, “We will need to be vigilant” because a booming economy can lead to a relaxation in lending standards.

Vigilance is code for being proactive, raising rates if the economy runs hot, even before any acceleration of inflation. Yet there’s a risk that the Fed will overreact to faster growth this year and into 2019, which is fueled by a one-time fiscal boost from tax cuts and a big increase in federal spending. That’s the recipe for a big economic slowdown late next year or in the first half of 2020.

Bank Stocks Fare Well

Bank of America, Wells Fargo and other bank stocks, which can benefit from higher short-term rates, especially when long-term interest rates rise even more, were only slightly higher before the Fed meeting statement on Wednesday, though JPMorgan Chase saw healthier gains. Bank of America and JPMorgan rose a little more after the announcement.

Even though the 10-year yield was slightly lower, the 2-year yield fell a little more. A wider yield spread is good for bank profits.

E-brokers are among financial stocks that benefit from a higher Fed interest rate, in part because  floating-rate margin loans for trading accounts are based on short-term rates that move in tandem with Fed policy. TD Ameritrade (AMTD) CFO Stephen Boyle said on the Jan. 23 earnings call that the next 25-basis-point increase to the Fed’s target rate could yield an estimated $60 million to $110 million in pretax income. Shares of Ameritrade were up slightly ahead of the Fed announcement and rose a little more later.

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