ZG - 4 Key Takeaways From The Fed's Policy Meeting

2023-11-01 17:41:00 ET

Summary

• Stock markets gained after Federal Reserve held interest rates steady.
• Strong Q3 GDP growth considered and potential rate pause in 2023 discussed.
• Banking sector stability and focus on achieving 2% inflation target.

Stock markets responded favorably after the Federal Reserve held interest rates steady again. Though markets widely expected the Fed’s decision to pause rate hikes, S&P 500 ( SPY ) and Nasdaq ( QQQ ) rose by more than 1% after the press release.

The first takeaway of assessing further firming is nothing new. The difference from the Sept. 20, 2023, meeting rate hold is that the stock market expects higher interest rates for longer. In the question and answer session, Powell said that the question of hiking rates more is secondary. Achieving a path to 2.0% inflation takes precedence.

There are four key takeaways from the Oct. 31 – Nov. 1, 2023 meeting.

1/ Strong Q3/2023 GDP

The Fed recognized that economic activity expanded at a strong pace in Q3 . Job gains moderated, as reported in September . The next job report this Friday might reaffirm this trend. Still, job growth is strong and unemployment remains low.

The Bureau of Economic Analysis posted GDP increasing at 4.9% at an annual rate in Q3 . This is above the Conference Board’s forecast of 4.5% . Despite disposable income falling, consumption growth drove the expansion. Still, this included an expansion in private inventories and included support from government spending.

Citing the objective of achieving maximum employment, The Fed maintained the target range for the federal funds rate at 5-1/4 to 5-1/2 percent. While it continues to send inflation toward the 2% target over the longer run, it will continue to assess the incoming data over the next two months.

2/ Potential Rate Pause in 2023

Fed watchers will recall that the central bank forecast raising rates by another 25 bps in its September meeting. When it meets again on Dec. 12-13, 2023 , its decision on rates will depend on the additional information available. As usual, the Fed wrote that “the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments.”

In addition, the Committee will continue reducing its holdings of Treasury securities, agency debt, and agency mortgage-backed securities, as described in its previously announced plans. The Committee is strongly committed to returning inflation to its 2 percent objective.

The relief rally following the meeting suggests that the stock market is adjusting to longer periods of tighter financial conditions. In addition, bond yields fell all across the board.

The 10-year Treasury bond ( US10Y ) fell significantly. The Treasury increased its quarterly refunding to $112 billion of securities . Investors unwilling to commit cash for that long may consider the 3-month T-bill ( US3M ) or the 6-month T-bill ( US6M ), which yields 5.47% and 5.53%, respectively. Risks are lower today that these debt instruments will reach 5.5% to 6.0%.

The 2-year Treasury bond ( US2Y ) also fell sharply. Investors will find this risk-free rate at a short-term maturity period highly appealing. The potential rate pause for 2023, pushed out to next year and dependent on the economic data, supports this view.

3/ Stable Banking Sector

The Fed said that the banking system is sound and resilient. However, the impact of tighter financial and credit conditions for consumers and small businesses (the Fed generalized them as households and businesses) is unknown. Monetary policy has a lag effect whose impact on them is uncertain.

In housing, 30-year mortgage rates are higher. Listings are higher but cancellations are rising, according to Redfin . Looking closer, real estate stocks fell after the National Association of Realtors, HomeServices of America, and Keller Williams were found guilty of conspiring to inflate commission rates. The order for three defendants to pay $1.78 billion caused a slump in real estate stocks: Redfin, Zillow ( Z ), and Opendoor Technologies ( OPEN ).

Regional banks already fell when they posted Q3/2023 results. The regional banking ETF ( KRE ) added only 0.4% at the time of writing. When asked if the Bank Term Funding Program (“BTFP”) would continue in March 2024, Powell said it would assess it in Q1/2024.

This did not help the sector’s stock performance. One of the stronger banks, PNC Financial ( PNC ), fell on the day. PNC stock has strong grades:

PNC said on its conference call that its acquisition of the $16 billion portfolio from Signature Bridge Bank would enhance its efforts in the private equity sponsor industry.

Truist Financial ( TFC ), whose stock yield is 7.33%, barely moved today. Investors are unimpressed with the merger-related and restructuring charges that hurt the regional bank’s EPS by $0.04 .

4/ Inflation Target of 2%

Fed Chair Powell cited the core PCE (personal consumption expenditures price index) at 3.7% as one of the good data points. The data points to a favorable trend that suggests the direction of inflation is heading toward 2.0%. Investors need to observe economic data that persistently suggests that inflation is slowing.

History provides a lesson tomorrow. In 1979, Paul Volker raised the Fed Funds rate above 17% . The economy entered a recession, letting Volker cut the rate to 9%. Interest rates rose again in late 1980 , causing a recession and higher unemployment. Only by October 1982 did inflation fall to 5% while long-run interest rates started to decline.

Your Takeaway

Investors may become complacent after the Fed left rates unchanged. When the committee watches the inflation rate data, the jobs report, and credit conditions to come up with its decision, investors should do so too.

Investors who have gains this year watched the index holding the larger market capitalization. Consider watching the Russell 2000 ( IWM ) more closely. This index will give investors a better sense of the health of smaller businesses.

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