Markets look to the Fed again to build on S&P 500 record as Congress continues to disappoint

August 21, 2020

5 minutes read

Federal Reserve Chair Jerome Powell arrives for a news conference following the Federal Open Market Committee meeting in Washington, December 11, 2019.

Joshua Roberts | Reuters

Market pros hold out little hope that Congress will agree to a stimulus package before September, but they will look to Jerome Powell in the coming week to provide a roadmap for what else the Fed might do to help the economy.

The Fed holds its annual Jackson Hole symposium starting Thursday, and it will conduct the Kansas City Fed-sponsored meeting virtually rather than against the backdrop of the Grand Tetons as it normally does at this time of year. The Fed chairman speaks Thursday morning on the implications for monetary policy and the Fed’s anticipated policy framework review.

The past week was a big week for markets, with the S&P 500 finally recovering its losses from the pandemic selloff and setting new all-time highs. Stocks have been big beneficiaries of the Fed’s easy policies and low interest rates, and Fed officials are widely expected to sound dovish when they meet in the coming week.

“I think we know the Fed’s all in. If anything they want the mechanicals to work right,” said Ed Keon, chief investment strategist at QMA. “The basic Fed policy is crystal clear. You’re going to have low rates for the foreseeable future. They will do whatever it takes.”

But Fed watchers expect Powell to go further than the Fed’s already extraordinary support for the economy and financial conditions, and offer guidance on new language and policies that will help the markets understand how long it might hold those low rates and extraordinary policies in place.

For instance, the Fed was expected to provide a more explicit forward guidance policy, and it could also introduce inflation averaging, meaning the Fed could specify that it could both undershoot and overshoot its 2% inflation target. Inflation has only occasionally surpassed its target over the past dozen years, since the financial crisis.

Michael Gapen, chief U.S. economist at Barclays, said he expects the Fed will introduce forward guidance and average inflation targeting at its September meeting. He expects the Fed’s policy review to examine all of its policies to determine which work best in different circumstances.

Since the markets collapsed in February and March, the Fed has cut rates to zero and helped increase liquidity with different facilities for different areas of the capital markets like commercial paper, municipal bonds and corporate bonds. It also created lending programs and continues to buy a large amount of Treasury securities and mortgages. Its balance sheet has now ballooned to $7 trillion.

With average inflation targeting, the Fed would allow the economy and inflation to run hotter than target, without immediately taking steps to tighten policy, according to Jim Caron, fixed income portfolio manger with Morgan Stanley Investment Management.

“What they’re saying is if the economy starts to recover, let’s say we get a vaccine, or the rate of infection goes down, and the equity market is on a tear, they’re not going to stop it,” said Caron. “They’re going to stay there for awhile. That’s what they’re trying to communicate.”

Where’s the stimulus?

As markets await clarity from the Fed, market pros are expecting less from Congress after first initially anticipating a stimulus package by early August.

“At this point, the thing I’m most thinking about is are we going to get a stimulus deal or not,” said Keon. “I think the politics are shifting beneath that.” He said some Republicans in Congress may be less inclined to spend on a big package ahead of the election.

Democrats and Republicans have been far apart in terms of the contents of the package. One hot button issue is the $600 supplemental weekly aid for the unemployed. It expired on July 31, and Republicans want to cut it to $200 a week while Democrats want to keep current levels. The White House meanwhile has moved to provide $300 a week in aid from FEMA funds but the states have to process those payments.

The two parties are also still far apart on the size of the package, after initially starting out with Democrats at $3 trillion and Republicans with $1 trillion.

“Some folks are discovering their inner budget hawks. It looks like the positions of the two sides are moving further away rather than closer together,” said Keon. “As the election moves up on us, the possibilities of a deal are going down…the markets are slowly moving toward the idea we don’t get stimulus deal and we might get a Biden presidency. It’s not panicking about it.”

The Democratic party held its convention this past week, formally nominating former vice president Joseph Biden to head the Democratic ticket. The Republican convention begins Monday. Biden leads President Donald Trump by an average 7.4 percentage points in the major polls, according to RealClearPolitics.com.

Michael Schumacher, director rate strategy at Wells Fargo, said he too is becoming more skeptical a stimulus deal will get done. “As the election season gets going, it appears to be getting harder and harder, not from a timing standpoint but from a lack of goodwill standpoint,” he said.

Strategists said if the economic data weakens, that could hurt stocks and get Congress back to negotiating a new package. There had been expectations a package would include a one-time payment for individuals and families, enhanced unemployment payments and aid for state and local governments.

Raymond James Washington policy analyst Ed Mills said the two sides are likely to come together, but without a catalyst forcing them it may wait until they need to pass a continuing resolution on the budget Sept. 30. “Democrats are not going to allow for an appropriations bill to pass that does not include additional support for the economy,” said Mills.

It’s the economy

There is some key data in the week ahead that should show how manufacturing and the consumer are faring.

Durable good is reported Wednesday, while personal income and spending data is reported Friday. Consumer confidence is Tuesday and consumer sentiment is released Friday.

Energy markets will be keeping a close eye on two tropical storms that are heading into the Gulf of Mexico and could make landfall early Wednesday. One storm, Laura is tracking close to Florida, and a second storm, possibly to be named Marco looks to be heading across the Yucatan Peninsula before entering the Gulf.

It would be unprecedented in the era of satellites and modern hurricane tracking technology for two storms to arrive within 24 hours. The Weather Channel reports there was such an occurrence in September, 1933.