Before The Bell
The market reacted with aplomb to the anxiously awaited monetary policy decision of the Federal Reserve, announced yesterday afternoon. Although the statement showed that the central bank plans to reduce its supportive activities in 2022 by tapering of its bond-buying program and to raise interest rates, the major equity averages, which were lower heading into the central bank’s decision, reversed course and moved notably higher during the final two hours of yesterday’s session. At the closing bell, the Dow Jones Industrial Average, the NASDAQ Composite, and the broader S&P 500 Index were up 1.1%, 2.2%, and 1.6%, respectively. The buying is expected to continue today, with the equity futures pointing to a sharply higher opening.
This morning, the data continued to point to a strong U.S. economy. The Labor Department reported that initial weekly unemployment claims came in at 206,000 for the week ending December 11th (up slightly from last week’s figure), while continuing claims were down to 1.84 million, a pandemic-era low. Meanwhile, housing starts came in at an annualized rate of 1.679 million in November (up nearly 12%), which was a very healthy level and well above the consensus expectation calling for 1.568 million starts. Building permits, which is an even more forward-looking indicator of residential construction, rose 3.6% in the latest quarter. Later this morning, we will get data on industrial production and capacity utilization. On a negative slant, the Philadelphia Fed Business Outlook fell to 15.4, versus the expectation of 30.0; it was the lowest reading for the year.
It is a relief rally we are seeing on Wall Street, which was already pricing in a less accommodative central bank on the monetary policy front next year and appears to like that the central bank’s policymakers are pivoting to try to curb increasing prices. The Federal Reserve’s monetary policy statement said that due to “elevated” inflation and a labor market that is moving toward full employment, the central bank plans to complete the tapering of its bond-buying program, thus not adding liquidity (cash) to the financial system, by March, 2022 instead of June (the pace of monthly asset purchases was reduced by $30 billion), and now may raise the federal funds interest rate three times in the new year. The presence of new forms of the coronavirus (specifically the Omicron strain) and a sharp rise in COVID-19 cases, though, will likely keep the first interest-rate hike from taking place until next May.
The longer range expectations of interest rate watchers also factored into the positive market reaction to this last Fed meeting of 2021. Based on the central bank’s statements, the Fed is now expected by most to raise rates about nine times through the end of 2024. This consensus, if fulfilled, would amount to a slower pace, and a lower ending level, less than many on Wall Street had started to forecast since the Federal Reserve began to take a more-hawkish view on monetary policy tightening with inflation looking more than transitory. New projections based on the median forecast by Fed officials see the federal funds rate rising to 0.9% by the end of 2022, to 1.6% by the end of 2023 and to 2.1% by the end of 2024. By comparison, the central bank raised rates 17 times in a three-year period from 2004-2006. The Fed sees 2.5% as the “neutral” level of interest rates, that is, neither restrictive nor supportive.
Yesterday’s late-day Federal Reserve-fueled relief rally on Wall Street was led by the technology sector, which was weaker in the sessions leading up to the Fed’s monetary policy decision. The specter of high inflation ahead, prompted by very hot readings on consumer and producer wholesale prices, brought sentiment that the Fed will be more aggressive in the coming years and that resultant higher borrowing costs would hurt the high-growth stocks. The fact that fixed-income yields held rather steady following the Fed’s monetary policy decision, gave a boost to the higher-growth equities. With bond yields, particularly the yield on the 10-year Treasury note which is running well below the 2.0% mark — and well below the double-digits seen during the United States’ last bout with spiking prices in the 1970s—Wall Street is thinking that the Fed will be able to slow prices without slamming the brakes on economic growth.
Looking forward, with the Fed’s decision now known and market participants clearly encouraged that the central bank is pivoting with its monetary policies to fight inflation, along with the debt-ceiling limit being raised by Congress this week, this has appeared to remove some uncertainty from the market, which Wall Street tends to like. Will these elements, along with mostly encouraging news on the economy, be the impetus to an early start to the annual “Santa Claus” rally on Wall Street? With the Federal Reserve now wedded to tightening the monetary reins and prices clearly at elevated levels, the financial and energy stocks should probably be given a closer look. Shares of the big banks, including JPMorgan Chase (JPM) and Morgan Stanley (MS), are trading higher in pre-market action. – William G. Ferguson
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.
