Federal Reserve Takes Small Step Toward Tapering; Stock Market Rallies

The Federal Reserve maintained its ultra-easy policy, as expected, on Wednesday, but signaled it’s getting a closer to tapering asset purchases. Yet the stock market didn’t seem at all fazed by the Fed’s modest step.




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The Fed’s new policy statement noted that policymakers had set a threshold of “substantial further progress” toward inflation and labor market goals before any reduction in asset purchases. “Since then, the economy has made progress toward these goals, and the Committee will continue to assess progress in coming meetings.”

After the last meeting on June 16, Fed Chair Jerome Powell said that economic conditions were “still a ways off” from achieving the “significant further progress.”

In his postmeeting press conference on Wednesday, Powell stopped short of repeating that phrase. “I’d say we have some ground to cover. I would want to see some strong job numbers.” However, Powell noted that the outlook for hiring looks strong.

Powell indicated he’s not overly worried about the economic consequences of the upsurge in Covid cases. “We’ve kind of learned to live with it.”

Powell also discussed the inflation outlook, saying that the inflationary impact of supply bottlenecks and hiring difficulties has been bigger than anticipated.

Much of the recent upsurge in inflation hasn’t been broad-based, but rather limited to a few categories like new, used and rental cars, Powell said. He acknowledged near-term upside risk to inflation, but added, “I have some confidence in the medium term that inflation will move back down.”

Stock Market Reaction To Federal Reserve Meeting

Major stock market indexes improved slightly but remained mixed after the Fed’s policy statement. Amid Powell’s press conference, the indexes continued to improve, though they faded at the close. The Nasdaq rose 0.7%, while the S&P 500 closed just below break-even after briefly turning positive. The Dow Jones fell 0.4%.

The 10-year Treasury yield edged ticked up slightly to 1.26% after the Fed pronouncements. The 10-year yield has tumbled from 1.57% since June 16, when the Fed surprised the stock market and bond market with a hawkish shift in its outlook.

Previously, Fed guidance had signaled no rate hikes before 2024. However, quarterly economic projections issued at the June meeting showed that 11 of 18 policy committee members saw at least two rate hikes as appropriate in 2023. In addition, seven of 18 policymakers indicated a view that the Fed should start hiking rates in 2022.

Yet that hawkish shift seemed to help the stock market. The 10-year Treasury yield fell after the June Fed meeting, as policymakers pushed back against a sense they had totally let down their guard against inflation. The lower 10-year yield, a positive for growth stock valuations, helped fuel a stock market rally.

Federal Reserve Taper Timing

Actual tapering of the Fed’s $120-billion per month in asset purchases won’t likely begin until late this year, or early in 2022. However, the stock market and, especially, the bond market could begin to price in a forthcoming policy shift. That might prompt a move higher for the 10-year Treasury yield, which would act as a headwind for growth stocks and the Nasdaq. Bank stocks, whose net interest margins would benefit from a steeper yield curve, could get a lift.

The Fed statement noted ongoing risk from the pandemic. While the economic risk from an unexpected Covid wave appears limited, the Fed may want to wait for evidence that job growth remains robust.

The Covid upsurge is hitting as the pandemic boost in unemployment aid will expire for 10-million sidelined workers by Labor Day. Meanwhile, the steady decline in filings for new jobless benefits has recently stalled near 400,000 per week.

On the other hand, elevated inflation readings since the Fed last met could make policymakers antsy to get started with tapering asset buys, the first step to tightening policy.

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