Minutes from the Jan. 30-31 Federal Reserve meeting released on Wednesday afternoon revealed that high stock valuations are becoming somewhat of a concern for monetary policy as policymakers weigh how quickly to cut interest rates. After the 2 p.m. ET release of the Fed minutes, the S&P 500 initially remained lower, but managed to scratch out a slight gain.
Fed Policy Shift?
The Fed policy statement and Chairman Jerome Powell's news conference on Jan. 31 sank the chances of a March rate cut, and the S&P 500 sold off, before hitting a new high two days later.
Powell's message — "Let's be honest: This is a good economy" — didn't sound like a reason to be less bullish, even if it meant the timing of rate cuts would slip. Powell also said the Fed wanted a strong labor market and that strong GDP growth wasn't a problem.
Still, markets have begun pricing out a couple of rate cuts this year. Stock prices, and easier financial conditions more broadly, are now on the Fed's radar as a reason to potentially keep interest rates higher than would otherwise be necessary.
Further, the Fed is rethinking its view of what level of interest rates is neutral. The implication is that the current Fed funds rate of 5.25% to 5.5% might not be as restrictive as it appears, so fewer rate cuts may be needed.
Fed Minutes On Financial Conditions
"Several participants mentioned the risk that financial conditions were or could become less restrictive than appropriate, which could add undue momentum to aggregate demand and cause progress on inflation to stall."
The implication is that a small number of Fed policymakers already see financial conditions, including stock valuations, as inappropriate. That's new. The December Fed minutes indicated that "many participants" were mindful that if financial conditions loosened too much, it would be harder for the Fed to achieve its inflation goal.
Still, the Fed's overall language on stock prices didn't signal a high level of concern at this point.
The Fed minutes alluded to "new highs" for the S&P 500 that were driven "mostly by the strong gains of large-capitalization technology companies."
"Broader measures of equity valuations were more subdued," the minutes said. "Equities appeared priced for continued economic resilience."
That's not suggestive of an emerging bubble.
Fed Rate-Cut Odds
After release of the Fed minutes release, markets were pricing in 6.5% odds of a rate cut on March 20, with 29% odds of a cut by the May 1 meeting. Odds of a Fed rate cut by the June 12 meeting stand at 72%. Markets are pricing in a year-end rate of 4.50%, implying Wall Street is on the fence over whether the Fed will cut three or four times (in quarter-point moves).
S&P 500
After the Fed minutes, the S&P 500 found its footing and turned higher, closing up 0.1%. The S&P 500 avoided what would have been a three-session losing streak, which hasn't happened since Jan. 4.
The 10-year Treasury yield, which rose 11 basis points to 4.295% last week on two hot inflation reports, climbed to 4.32% on Wednesday, near its highest level this year.
Be sure to read IBD's The Big Picture column after each trading day to get the latest on the prevailing stock market trend and what it means for your trading decisions.
