The Federal Reserve maintained its ultra-easy policy as expected on Wednesday, but indicated it is closer to phasing out asset purchases. After the 2 p.m. policy statement, the stock market, while mixed, did not seem phased at all by the Fed’s modest move.
The Fed’s new policy statement noted that policymakers had set a threshold of “significant further progress” toward inflation and labor market targets before reducing asset purchases. “Since then, the economy has made progress toward these goals, and the committee will continue to review progress in upcoming meetings.”
Stock market investors will be watching Fed Chair Jerome Powell’s 2:30 p.m. press conference to get a clearer picture of likely taper timing, but this fall looks like a possibility.
After the latest Fed meeting on June 16, Powell said economic conditions were “still a long way off” from achieving “significant further progress.” It would be a surprise if Powell were to repeat that phrase today.
Stock Market Reaction to Federal Reserve Meeting Federal
Major stock market indices improved slightly after hitting record highs on Monday and pulling back yesterday, but remained mixed following the Fed’s policy statement. The Nasdaq rose 0.6%, while the S&P 500 moved slightly higher. The Dow Jones capped the loss to 0.3%
Ten-year Treasury yields fell to 1.25% after the Fed’s statement. The 10-year yield has fallen from 1.57% since June 16, when the Fed surprised the stock and bond markets with an aggressive shift in its outlook.
Previously, the Fed’s guidelines had signaled no rate hikes before 2024. However, quarterly economic forecasts released at the June meeting showed that 11 of the 18 policy committee members saw at least two rate hikes in 2023. position that the Fed should start raising interest rates in 2022.
Still, that aggressive shift seemed to help the stock market. Ten-year Treasury yields fell after the Fed meeting in June, as policymakers backed off feeling that they were totally wary of inflation. Lower 10-year yields, positive for growth stock valuations, boosted the stock market.
Descending Timing of the Federal Reserve
The actual winding down of the Fed’s $120 billion a month in asset purchases is unlikely to begin until late this year or early 2022. However, the stock market and especially the bond market could start to price in an impending policy shift. That could lead to a rise in 10-year Treasury yields, posing a headwind for growth stocks and the Nasdaq. Bank stocks, whose net interest margins would benefit from a steeper yield curve, could see gains.
The Fed statement pointed to the ongoing risk of the pandemic. While the economic risk of an unexpected Covid surge seems limited, the Fed may want to wait for evidence that job growth remains robust.
The Covid upswing strikes as the pandemic increase in unemployment aid for 10 million sidelined workers is set to expire by Labor Day. Meanwhile, the steady decline in new unemployment benefit claims has recently stalled near 400,000 a week.
On the other hand, high inflation rates since the Fed’s last meeting could make policymakers hesitant to begin phasing out asset purchases, the first step towards policy tightening.
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