ECONOMY
Why The Federal Reserve May Let Down The Dow Jones Tomorrow
JED GRAHAM 03:50 PM ET 06/09/2020
The Federal Reserve meeting this week, like the last meeting, probably won't produce any consequential action. Rather than doing more, Fed policymakers have been easing up on the gas since hitting also sorts of speed records at the end of March. Now, worries about a possible Fed letdown could start to become a hindrance to further Dow Jones gains.
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Three things have changed from the last meeting that could make the Fed's lack of policy thrust and clarity an issue for the Dow Jones Industrial Average and broader stock market.
Federal Reserve Signals It's OK With Interest-Rate Rise
First, the Fed didn't seem to bat an eye as interest rates surged last week, capped off by Friday's shockingly good jobs report. The 10-year Treasury yield jumped 35 basis points to 0.9%, highest since March 20. Yet instead of ramping Treasury purchases back up, the Fed decelerated its quantitative easing further on Monday. The weekly pace of Treasury purchases has slowed to $20 billion, down from $22.5 billion last week and a peak of $375 billion in the week of March 23-27.
Now Wall Street is starting to wonder what level the 10-year Treasury yield has to cross before the Fed moves to put a lid on interest rates. Ultralow interest rates are supportive of economic growth and higher stock market valuations.
Fed Quarterly Economic Projections
Second, the Fed will release quarterly economic projections for the first time since the crisis. Unless policymakers have suddenly become bullish about a V-shape recovery, the Fed will project high unemployment at least through the end of 2020. If so, that might raise an uncomfortable question: Why is the Fed doing less, not more, to boost employment?
Federal Reserve Programs Lend Billions, Not Trillions, So Far
The Fed has had an easy answer to that question: New lending facilities for big business, small business and municipal governments were getting ready to launch, with capacity to lend trillions. Now the answer isn't quite as easy. Most have already launched, and the initial takeup has been moderate.
While another big stimulus effort, the Main Street Lending Program, still has yet to launch, Wall Street has reined in expectations of how much demand there will be for the Fed programs.
As Fed Chair Jerome Powell has said, the Fed is providing loans not grants. Small firms may be much less eager to take on liability than to get free money. The Small Business Administration's Payroll Protection Program initially saw insatiable demand for its forgivable loans, but demand waned as firms worried that the rules weren't forgiving enough.
What Will Trigger The Next Policy Response?
At some point, perhaps as soon as Wednesday, policymakers will address concern about a premature interest-rate hike by providing guidance about the conditions needed for a hike. The Fed could, for example, specify an unemployment rate no higher than 4.5% and core inflation of 2.25%.
As long as such targets are far off, short-term interest rates tied to the Fed's benchmark policy rate would remain anchored. But longer-term interest rates that influence rates on mortgages and other consumer loans could paint a different picture.
As federal deficits soar close to $4 trillion or more this year, some economists see a risk that a surge in Treasury issuance will push up longer-term interest rates unless Federal Reserve quantitative easing sops up much of the supply.
Faith in the Fed is still running high on Wall Street after policymakers helped resuscitate the Dow Jones index. Although fiscal policy played a huge role, it's no coincidence that the Dow found a bottom on March 23, the day the Fed announced unlimited quantitative easing. There should be little doubt that the Fed will again do everything it can to ride to the rescue if needed.
Yet that faith may not preclude a Fed letdown. Here's the potential problem if the Fed signals it's now on cruise control and that it will take some trigger to make it change course: the Dow Jones may not like the trigger, possibly higher long-term interest rates or lost momentum for the economic recovery.
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