Note: This story is being updated following the Fed meeting at this link.
There's no chance that the Federal Reserve will raise its key rate with this afternoon's policy update, though chair Jerome Powell is unlikely to take a December rate hike off the table at his news conference. Yet if today's Fed meeting is as uneventful as expected, that will be bad news for the S&P 500.
Here's why: 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. That's because Fed policy isn't working as anticipated. High borrowing costs have yet to take down consumer spending or the job market. It may take a steeper S&P 500 sell-off for the Fed to get its way.
Long Lags For Federal Reserve Tightening
A number of factors have blunted the impact of the most aggressive tightening of monetary policy 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 Falls As 10-Year Treasury Yield Surges
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's more economic damage to come.
The 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% early Wednesday — 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. 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.
JOLTS, Treasury Refunding
On Wednesday, the Labor Department said that employers posted 9.553 million job openings in September, a bit higher than expected. August openings were revised down to 9.497 million from an initially reported 9.61 million.
The percentage of private-sector workers who quit their jobs held at 2.6% for a third straight month. That's come down from a peak of 3.3% back to a level that prevailed before the pandemic, a sign that the labor market has eased.
Earlier Wednesday, Treasury said upcoming bond sales will tilt more to shorter-term bonds, which could mean a bit less pressure on the 10-year Treasury yield.
On Monday, the Treasury Department said it expects to borrow $776 billion in the fourth quarter, down from an earlier estimate of $852 billion, partly due to an increase in tax revenue. First-quarter borrowing in 2024 is expected to be $816 billion. The amounts reflect both new borrowing and debt issuance to replace maturing bonds.
After those reports and ADP's softer-than-expected estimate that private employers added 113,000 jobs last month, the 10-year Treasury yield eased to 4.8% from 4.875% on Tuesday.
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.
One might suspect 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.
The S&P 500 rose 0.4% in Wednesday morning stock market action, following back-to-back gains to start the week.
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