We have become accustomed to taking “off” month announcements by the Federal Reserve’s Federal Open Market Committee (FOMC) in our stride. The quarterly decisions that are accompanied by a press conference are the ones where changes are made, so they are, logically enough, the ones on which investors focus. True to form, yesterday’s announcement contained no change to the Fed Funds rate, but there were two things, one said and one unsaid, that could be viewed as fundamentally changing the outlook for stocks as the year ends.
The “said” was contained in the accompanying statement, where the FOMC made a significant change to the language they used to describe fixed investment by U.S. businesses. Such spending, they said, has “moderated from its rapid pace earlier in the year,” as opposed to describing it as having “grown strongly."
Often, changes in the Fed’s language are subtle and there is a tendency to read vast amounts into minor changes, but this was clearly a different take on business spending.
How you view that in terms of its potential impact on the markets depends on what you believe caused it. There are three possible reasons. The first would be if businesses were slowing investment because they see demand for their goods and services slowing soon. In other words, it could be a warning of an impending economic slowdown. However, that seems unlikely given the strength of the recent earnings season, the generally upbeat guidance issued by companies, and household spending that the Fed says “continued to grow strongly."
The second, and most benign reason would be if it was just a natural tailing off of investment after an abnormal boost caused by tax cuts and changes to the way investments are treated for tax purposes. Obviously, that would be a lot less concerning, and could even be regarded as a positive. It would mean that the productivity and capacity of American businesses had been given a big boost, but there would be little or no inflationary pressure.
The third, and most worrying explanation would be if businesses were slowing down the pace of investment in response to interest rate hikes. I am sure the Fed would regard that as a success, as the purpose of the hikes is to slow the pace of growth of the economy slightly, before it leads to inflationary pressure.
For the market, however, if moves to this point are already producing that reaction, it makes the FOMC’s later-stated expectation of “further gradual increases” scary rather than reassuring.
The most likely scenario is that it is a combination of the last two things. That would be consistent with the market reaction so far and would make it most likely that the renewed selling we are seeing will be temporary. Before long, traders will be looking at the economic strength that is prompting the rate hikes and the fact that, so far, the economy has absorbed them well, and we will begin to move higher again.
The thing left unsaid in the Fed’s announcement is far less impactful in terms of the economy but may go some way towards explaining the market’s negative reaction yesterday and this morning. The statement contained no mention of the turmoil that has gripped the market for the last month.
That may come as a surprise to younger readers who are used to Ben Bernanke and Janet Yellen’s frequent nods to market moves, but to those of us who have been around longer it is neither surprising nor unwelcome. There was a time when the Fed was consistently and quite deliberately aloof from the daily gyrations of the stock market, believing that their role was to focus on the long-term prospects for the economy, not to please traders.
The move away from that was a result of the trauma of 2008-9 but, especially given the tendency of the current President to equate the market with the economy and take credit for its strength, it is probably a good time to reassert the more traditional view that they are not the same thing.
However, don’t think that a market used to being one of the driving forces of economic and monetary policy will take that laying down. It will likely cause a hissy fit from traders, even if the data continue to show that the Fed has got everything right so far. They have managed to normalize rates and reduce their bloated balance sheet without any major disruption to either the market or the economy.
That is quite a feat.
In the short term then, the market, miffed at being put in its place by the Fed and with some real concerns about further rate hikes having a negative impact, is trading lower, and further volatility looks likely. Until there is evidence that those concerns are justified however, the numbers clearly indicate that we have strong growth in the labor market, consumer spending and corporate profits, while not putting any undue pressure on inflation, and that points to us moving higher again before long.