CART - What The Fed's Rate Hold Means For The Markets

2023-09-20 17:42:17 ET

Summary

• The Federal Reserve will continue reducing its holdings of Treasury securities, agency debt, and agency mortgage-backed securities, which will have a negative impact on stock markets.
• The Fed kept interest rates the same due to the lag in monetary policy's effects on the economy and uncertainty about the impact of tighter credit conditions.
• Elevated interest rates will pressure dividend-income investors and may lead to a downturn in Real Estate Investment Trusts (REITs) and other sectors.

The Federal Reserve issued an FOMC statement that it will hold interest rates at current levels. Buried in the middle of the statement is the Committee’s plans to continue reducing its holdings of Treasury securities, agency debt, and agency mortgage-backed securities. This is consistent with previously announced plans. The latter action will have an interest rate increase effect on stock markets.

Comments on Economic Indicators

The Fed cited the strong pace of economic expansion, the low unemployment rate, and strong job gains. Although the Fed is achieving healthy employment, inflation is still elevated. To achieve maximum employment and lower inflation at a rate of 2% over the longer run, the Committee reiterated its target range for the federal funds rate at 5-1/4% to 5-1/2% .

The S&P 500 ( SP500 ) fell at 2 p.m. on low volume. This is a “sell on the news” reaction to the widely expected Fed decision.

The Fed is content to keep rates the same for two main reasons. First, it recognizes the lag with which monetary policy acts on the economy and on inflation. Second, the decision implies it wants the commercial real estate market, which has a big impact on regional banks, to adjust to current rate levels. Furthermore, the Fed is uncertain about the impact of tighter credit conditions for households and businesses.

Tight credit conditions discourage companies from operating at rising costs. The rates will weigh on hiring staff. Conversely, more workers are going on strike. For example, writers and actors are demanding higher wages. The United Auto Workers are on strike simultaneously at Ford ( F ), General Motors ( GM ), and Stellantis ( STLA ).

During the Q&A session, Chairman Powell said that it would monitor the impact of the UAW strike on output and inflation.

What Target Range of 5-1/4% to 5-1/2% Means

Elevated rates will pressure dividend-income investors. Ahead of the FOMC statement, Real Estate Investment Trusts (“REITs”) fell into a downtrend pattern. The sector is pricing in Powell’s suggestion of higher interest rates for longer than markets expect. Income investors are not accustomed to the potential for rates staying at 5.25% to 5.5%. Before and during the global pandemic in 2020, REITs could raise debt to fund acquisitions. Today, it must take on greater risks to expand its profit margins.

Realty Income ( O ), which traded steadily at $60-$63 throughout 2023, broke down in July. Shareholders are concerned that the firm overpaid Blackstone ( BX ) for The Bellagio Las Vegas .

Markets already punished companies in the telecom and media sector for their high debt levels. The longer rates remain above 5%, the higher the risk that firms must renew their upcoming debt at higher rates. Since I last mentioned them in my jobs and inflation reports, Verizon ( VZ ) and AT&T ( T ) bounced back from their lows. Income investors snapped them up for the 7.89% and 7.12% dividend yield, respectively.

What Asset Reduction Means

Quantitative easing introduced too much money in the stock market and the economy. The Fed’s reduction of treasuries and other securities should send the widely followed indices lower. The Russell 2000 ( IWM ), Nasdaq ( QQQ ), and S&P 500 ( SPY ) risk going nowhere or falling from here.

Investors may consider holding treasury exchange-traded funds. The tickers are USFR, SGOV, TFLO, OPER, BIL, and UBIL. Note that the iShares 0-3 Month Treasury Bond ETF ( SGOV ) re-extended its waiver for a lower expense ratio at 0.07% until June 2024.

My list of bond ETFs are JNK, AGG, BND, TLT, IEI, IEF, SHY, GOVT, VGSH, VGIT, SCHO, SCHR, SPTL, TLH, and VGLT.

Notable Commentary from Q&A

Fed Chair Powell said that the restrictive policy is bringing inflation levels down after three months. He said the last jobs report rebalanced the labor market favorably. This positions the committee to review the economic data on a month-to-month basis. It will assess that data to decide when to raise rates by 25 bps, either in November or December.

Powell said the Fed does not know how long it will keep rates at these levels. That is the next phase of Fed decision-making. The core personal consumption expenditure (“PCE”) is falling, while rising energy prices increase overall inflation. The Fed reasoned it excluded energy prices due to the inherent volatility. Furthermore, rising oil prices recently do not necessarily signal the direction of inflation that could affect spending.

Recently, oil prices rose very rapidly. If it approaches the psychological ceiling of $100/bbl and stays there, the Fed may rethink its stance on high energy prices. Investors who missed out on the energy rally should add Exxon Mobil ( XOM ) and Chevron ( CVX ) to the list. Those stocks both trade at a profitability grade of A+, according to Seeking Alpha’s quant score.

The Takeaway

The Fed’s target range of 3.9% by the end of 2025 is only a guide. It does not resonate well with stock market traders, who have a short-term time frame. Instacart ( CART ) and Arm ( ARM ) would be more suitable instruments for them . Investors holding for the long-term should continue to prepare for the market adjusting to the Fed’s restrictive policy. Consider parking some of the capital gains into money market funds. Start a position in energy stocks at lower prices. And be wary of high-flying technology stocks and IPOs.

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