The Federal Reserve did what everybody expected, leaving its key rate and policy guidance unchanged. We got more of the same from Fed chair Jerome Powell at his postmeeting news conference, keeping a rate hike on the table for the Dec. 13 meeting, but markets are concluding that another rate hike is doubtful. The S&P 500 extended gains, looking for its third-straight positive finish.
Powell Offers Mixed Message
Powell kept the Fed's options open, repeating his recent cautionary words that further tightening may be warranted if growth continues to run hot.
"We will continue to make our decisions meeting by meeting," Powell said. He indicated that the Fed simply isn't confident either that more tightening will be needed or that more tightening can be avoided.
Powell said that the tightening in financial conditions with the rise in the 10-year Treasury yield could reduce the need for further short-term rate hikes. But that's only if the tightening in financial conditions is persistent, he stressed.
Still, Powell didn't sound especially worried about the recent fast pace of growth. He talked about how wage growth is coming down and higher immigration has helped loosen the job market. Most importantly, Powell offered some reasons why he still thinks Fed policy will work as intended, perhaps with more of a lag.
Asked whether the rise in the 10-year yield will finally succeed in slowing the consumer, Powell highlighted the 30-yeear mortgage rate hitting 8%.
"The effects of this could be quite significant," he said. He added that consumer surveys say it's not a good time to buy durable goods.
Fed Rate Hike Odds
Odds of a rate hike at the Dec. 13 meeting fell to 19% from 29% on Tuesday. For the Jan. 31 meeting, odds of a rate hike eased to 27.5% from 39%.
Fed Meeting Policy Statement
The Fed's policy update included the same key language reiterated at each meeting since May. The rate-setting committee will continue to assess "the extent of additional policy firming that may be appropriate" to return inflation to 2%.
That doesn't imply a bias toward further rate hikes, but it does signal that there's no consensus among policymakers that the Fed has done enough.
The Fed's status quo means the economy is still too strong and inflation too high — despite 5.25 percentage points of rate hikes since March 2022. Up to now, Fed policy hasn't working as anticipated.
Fed Frets Over Strong Growth
A number of factors have blunted the impact of the most aggressive monetary policy tightening in more than 40 years.
Consumers stored up an extra $2 trillion or so in savings early in the pandemic. A massive 8.7% increase in Social Security checks in January fortified spending for the fast-growing senior population, which is less exposed to rate hikes because borrowing tends to decline later in life. Most homeowners locked in low fixed mortgage rates before the Fed began hiking, and S&P 500 companies likewise took advantage of cheap rates while they could.
Meanwhile, the ramping up of $1 trillion in federal funding is supporting a surge in investment on manufacturing, mining and infrastructure projects. Plus, a huge S&P 500 rally through July that was fueled by the start of a generative AI boom largely reversed the Fed's tightening of financial conditions, boosting household wealth and business investment.
Stresses are emerging with the recent jump in the 10-year Treasury yield close to 5% from under 4% on July 31. The accompanying surge in the 30-year mortgage rate close to 8% has seen applications for mortgages to buy a home dive to the lowest level since 1995. Delinquencies on subprime auto loans have hit a record, according to Fitch Ratings.
Yet most of the economy is at least somewhat insulated from the impact of higher rates, so the lag between Fed tightening and its full economic impact appears longer than normal.
S&P 500 Linked to 10-Year Treasury Yield
The Fed has slowed — and quite likely stopped — hiking rates as it waits for their effects to play out. But even if we're in a holding pattern, there may be more economic damage to come.
The potential problem for the S&P 500 is that the stock market is one of the parts of the economy most clearly exposed to high interest rates — particularly the 10-year Treasury yield. Stock market price-to-earnings valuations hinge partly on the 10-year yield, which analysts use to figure out what future earnings are worth today. The higher the rate, the lower the valuation on paper.
The Fed has much greater control over short-term interest rates than the 10-year Treasury yield. That's why the 10-year yield — around 4.81% just before the Fed announcement — is well below the 5.25% to 5.5% range for the federal funds rate and 5.07% rate for the 2-year Treasury yield.
But the Fed has contributed to the 10-year yield's recent jump in a number of ways. Most notably, the Fed is unloading $60 billion per month worth of Treasuries purchased early in the pandemic, increasing the supply of government bonds sold to the public. That's expected to go on as long as the status quo continues.
The status quo also means higher borrowing costs and interest payments for the federal government, which further boosts supply and exacerbates the unsustainable trajectory for the federal debt.
Fed Puts Focus On 10-Year Treasury Yield
Numerous Fed officials have suggested that the rise in the 10-year Treasury yield — assuming it lasts — means there's less need to raise the Fed's short-term borrowing rate.
Reading between the lines, it seems that the Fed would be quite content to see the 10-year Treasury yield's strength continue, keeping pressure on the S&P 500 to help hasten an economic slowdown.
As Powell spoke, the S&P 500 extended its rise to 1.1% in Wednesday stock market action, following back-to-back gains to start the week. The 10-year Treasury yield eased to 4.77% from 4.875% on Tuesday.
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.
